After a tough summer for the bond market with yields skyrocketing and the absence of talks about easing the monetary policy, markets decided to provide a little bit of relief at least in the last week. Yields have certainly been in a strong uptrend since May, but it seems that the relief and the reversion of the trend may happen until the end of the year.
Since the 4th of October when yields reached multi-year highs, they dropped significantly. Bund yield fell from its intraday high of 3.02% to 2.73% in a matter of a week. The US 10-year Treasury yield reached a high at the level of 4.88%, also followed by a plummet to 4.57%. I would argue that it happened due to two different reasons. Firstly, West Intermediate crude oil (WTI) fell from an intraday high of 95.03$ on the 28th of September to 84$ which alleviated the market’s concerns about the secondary inflation wave led by rising oil prices. Secondly, new global uncertainty emerged as the Israeli-Hamas war started and the regional escalation may be the headline tomorrow. Flight to safety pushed the bond prices up swiftly. However, regional escalation is both bullish and bearish for bonds. Bearish as the oil prices due to Iran’s and Saudi’s possible involvement may push oil prices significantly higher and bullish as the war would strengthen the flight to safety mood.
Bonds of the peripheral countries in Europe such as Italy, Spain, and Croatia have appreciated less than Bunds resulting in widening the spreads as the move in bonds was towards core countries. The spread between the Bund and the 10Y Italian Bond briefly reached 207 bps on the 6th of October, but it has been narrowing since then. A huge headwind for the mentioned spread is the higher Italian deficit than previously expected which even spurred concerns of Italy and France entering an Excessive deficit procedure in 2024 if the program restarts in 2024 based on deficits at the end of 2023. 10Y Spanish bond is following the same trend as Italy due to both countries having significant portions of their debt under ECB programs such as PEPP. In the case of active QT or at least speeding up the passive QT, selling pressure on both Italian and Spanish bonds would be notable. On the other hand, this would not influence Croatian bonds as there are no Croatian bonds held under the ECB programs. Fleeing from Italy and Spain would probably incentivize investors to leave Croatian bonds too, but the magnitude should be lesser than in Italy and Spain. That implies that the spread between Croatian bonds or Croatian bonds and Spanish bonds should narrow further. Also, the 10Y Treasury – Bund spread widening swiftly should continue as long as the data from the US economy stays positive and above expectations and the economic outlook in Europe stays gloomy. Furthermore, the much higher issuance of Treasuries this year is pushing Treasury yield further up which is not the case in Europe.
The bond market experienced a challenging summer with surging yields, but there’s been relief in the past week, and a trend reversal may occur by year-end. Yields in the US and Germany dropped from multi-year highs in early October due to falling oil prices and escalating regional tensions. The Israeli-Hamas conflict had a dual impact on bonds, offering both bullish and bearish influences. Peripheral European countries like Italy, Spain, and Croatia saw less appreciation in their bonds compared to core countries, widening spreads. The 10Y Treasury – Bund spread is widening due to favorable US economic data and a gloomy European economic outlook, coupled with increased Treasury issuance.
Source: Bloomberg, InterCapital