LONDON — Euro zone government bond yields bounced off multi-month lows hit earlier in the week on Friday as a recent rally on expectations that central banks will raise rates less aggressively began to peter out.
Shorted dated bond yields also extended their rise as euro zone banks were set to repay 447.5 billion euros ($472 billion) of multi-year loans to the European Central Bank, slightly more than expected.
Banks had until recently been sitting on 2.1 trillion euros worth of cash from the ECB’s Targeted Longer-Term Refinancing Operations (TLTRO) but are now repaying them.
The ECB raised the borrowing costs on them last month to incentivise repayments as part of its broader policy tightening efforts to combat red-hot inflation.
The announcement pushed yields on shorter-dated bonds, often used as market collateral, higher on Friday. Germany’s two-year yield was 2.13% up 6 basis points, Italy’s two-year yield was up nearly 8 basis points to 2.63%.
The repayments put upward pressure on short-dated bond yields, as assets tied up at the ECB as collateral for these emergency loans will now be returned to the market and the excess liquidity created by the loans chasing collateral will also reduce.
That is relief for euro zone bond markets, plagued by a shortage of bonds for investors to buy after years of ECB bond purchases.
The spread between interest-rate swaps and Germany’s two-year yield tightened in another sign that traders expect scarcity to ease.
“It’s a bit hard to know what consensus was, but it’s fair to say the (repayment) amount is larger,” said Antoine Bouvet, senior rates strategist at ING.
“The market implications are: cash bond yields will underperform (interest rate) swaps – and so that means swap spreads tightening – collateral scarcity around year end might be a bit less acute and this may reassure the ECB and lower the pressure on them to take measures to reduce the balance sheet.”
The ECB is expected to lay out how it will run bonds off its balance sheet, a process known as quantitative tightening, at its policy meeting next Thursday.
Across the borader market, Germany’s 10-year government bond yield, the benchmark for the euro zone, rose 6.5 basis points to 1.88%.
That reversed a sharp fall in recent weeks that saw it hit 2-1/2 month lows earlier this week at 1.753%, dropping from eight-year highs of 2.53%.
Friday’s moves come as investors are starting to position themselves ahead of a busy week of central bank meetings with the Federal Reserve, Bank of England and ECB all meeting and expected to slow their rate hikes to 50 basis point moves.
Italy’s 10-year yield was 3.77%, up 8 basis points on the day, and the gap between Germany and Italy’s 10 year yields stood at 189 bps.
Slightly higher than expected U.S. producer pricesfor November, which sent U.S. yields higher, also gave European yields a nudge higher. (Reporting by Alun John; editing by Yoruk Bahceli and Angus MacSwan)