Federal Reserve hint boosts euro zone government bonds

Euro zone government bond yields rose on Monday after comments from Federal Reserve chair Janet Yellen boosted the case for a US interest rate rise in June or July and data pointed to a brighter outlook for Europe's economy.

The Fed should raise interest rates “in the coming months” if the economy picks up as expected and jobs continue to be generated, the Fed chief said on Friday. St Louis Fed president James Bullard added that global markets appear to be “well-prepared” for a summer rate hike.

“Yellen is considered one of the mightiest doves at the Fed, so her comments do raise the probability of a hike in the summer although there is some conditionality to that,” said Norbert Wuthe, rate strategist at Bayerische Landesbank.

A generally hawkish tone from Fed speakers this month has prompted markets to reassess the outlook for US rate hikes.

The probability of a rate rise at the Fed’s June 14th-15th meeting rose to 34 per cent from 30 per cent before Ms Yellen’s remarks, according to CME Group, where the futures contracts are traded. Bets on a rate increase in July have edged up to 60 per cent, more than double the estimate from a month ago.

Germany’s 10-year Bund yield, the benchmark in Europe, rose 2.1 basis points to 0.17 per cent, off an 11-day low on Friday at about 0.12 per cent. Irish 10-year yields were just under 0.8 per cent.

Upbeat news from the euro area helped keep regional bond markets on the back foot. Euro zone economic sentiment improved more than expected in May and inflation expectations among companies and consumers rose, data from the European Commission showed on Monday.

Other data showed the French economy grew a stronger-then-expected 0.6 percent in the first quarter. German annual inflation clambered out of negative territory in May but only as far as zero, showing price pressures in Europe’s largest economy remain weak despite the European Central Bank’s ultra-loose monetary policy.

Tuesday brings the first or flash estimate of euro zone inflation in May.

The ECB, which meets on Thursday, will likely have a rare opportunity to raise some of its inflation forecasts for this year and next thanks to a rebound in oil prices, giving it some breathing space to allow its stimulus measures to work their way into the economy.

“[ECB President Mario] Draghi will be keen to prevent any sell off in bonds, so he will probably try to nuance any change in inflation forecasts and highlight that measures they have taken already still have to kick in,” said Martin Van Vliet, senior rates strategist at ING.

Other euro zone bond yields were 1-2 bps higher on the day, while overall trading was subdued with US and UK markets closed for a holiday.

A supply-heavy week put some pressure on debt markets. Analysts estimate about 25 billion euros worth of bonds will be issued in the euro zone this week.

Still, Italy sold 7.5 billion euros ($8.4 billion) in bonds on Monday paying less than it did a month ago, after Greece last week reached a breakthrough deal with creditors that fuelled demand for higher-risk euro zone debt.

– (Reuters)