FX.co ★ European Bond Rout Deepens on Inflation Worries

European government bonds extended their sell-off in early September, with Germany’s 10-year Bund yield rising above 3.3% for the first time since May 2011. French yields climbed to their highest level since November 2008, Dutch yields reached 15-year highs, and Italian and Spanish yields advanced to near two- and three-year highs, respectively. The renewed pressure on sovereign debt followed a combination of higher oil prices and increasingly hawkish signals from major central banks, which reinforced expectations of further interest rate increases. Markets are now pricing the ECB’s deposit rate at about 2.7% by December, implying roughly an 80% probability of a second rate hike after an anticipated move as early as September. At the same time, Fed Chair Kevin Warsh cautioned that inflation has not slowed meaningfully and that the Federal Reserve still has “work to do,” leading markets to assign a 66% probability to a September rate hike.