German government bond yields rise, Italy outperforms

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Yields on German government bonds rose on Wednesday on hopes of progress in Ukraine peace talks as markets awaited the outcome of the Federal Reserve’s policy meeting.

Global stocks surged after fresh talk of a compromise from Moscow and Kyiv on Ukraine’s non-NATO status and China’s pledge to roll out more fiscal stimulus boosted appetite for the risk.

“Markets are focused on a possible solution to the Ukraine conflict, hoping there will be no escalation,” said Eoin Walsh, portfolio manager at TwentyFour Asset Management.

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“Because of this, attention has returned to what central banks could do in terms of monetary tightening with less tension on the geopolitical front,” he added.

Germany’s 10-year government bond yield, the benchmark for the euro zone, rose 6 basis points (bps) to 0.38%, after hitting its highest level since November 2018 at 0.403%.

Germany sold 3.4 billion euros of 10-year Bunds at a price implying an average yield of 0.38% against 0.31 at an auction on February 16.

The yield on two-year bonds, which is more sensitive to changes in interest rates, rose by 6.5 basis points to -0.35%. It reached its highest since September 2015 at -0.214% on February 7.

Italian bond prices outperformed their peers, with the 10-year yield falling 1.5bps to 1.895% and the spread between Italian and German yields narrowing to 150bps.

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“Expectations of joint EU debt issuances have recently supported Italian bond prices,” said Massimiliano Maxia, senior fixed income specialist at Allianz Global Investors.

“But today their outperformance is more related to short BTP hedges after a recent sell-off,” he added.

Italian 10-year yields jumped 30 basis points to 1.9% after a hawkish turn by the European Central Bank on March 10.

Ahead of the ECB’s monetary policy meeting, the Italian-German gap narrowed due to expectations of debt sharing between eurozone countries and looser fiscal rules after the reform of the stability pact, which EU members are expected to discuss this year.

Investors were still weighing the impact of the war in Ukraine and wondering whether the risks of stagflation might trigger a more dovish stance from central banks.

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“We think the ECB’s forecast for economic growth is overly optimistic, both in the downside scenario and in the severe scenario,” said Walsh of TwentyFour Asset Management.

ECB Vice President Luis de Guindos and policymaker Joachim Nagel played down the risks of stagflation.

The Fed, which wraps up its policy meeting later today, is expected to step up the fight against inflation with the first in a series of rate hikes this year.

Money markets continue to price in around 170 basis points of Fed rate hikes by December 2023.

But investors appear to be more focused on how the U.S. central bank plans to end its bond-buying program and the future pace of maturing bond reinvestments.

“While stagflation fears are hard to dismiss and QT (quantitative tightening) could eventually lead to policy tightening, our economists expect the macro backdrop to remain resilient enough to keep the FOMC going,” they said. Commerzbank analysts said in a note to clients.

(Reporting by Stefano Rebaudo, editing by Mark Potter and Emelia Sithole-Matarise)

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