German short-term borrowing costs climbed sharply on Tuesday as investors increased bets that major central banks will keep monetary policy restrictive for longer.
At the same time, longer-dated German bonds recovered slightly after a period of heavy selling.
German Two-Year Yield Hits Highest Level Since 2023
Germany’s two-year Schatz yield, which is highly sensitive to interest-rate expectations, rose to its highest level since late 2023.
The move reflected growing expectations that central banks may need to deliver further interest rate increases as higher energy prices add renewed pressure to inflation.
Short-term bonds have come under particular pressure because markets increasingly expect monetary policy to remain tight well into 2027.
German Bund Yields Ease From Multi-Year Highs
Longer-term German government bonds performed slightly better.
Germany’s benchmark 10-year Bund yield slipped from its highest level since 2009 and traded near 3.518%.
Meanwhile, the 30-year German bond yield fell to around 3.875%, ending a three-session run of increases.
The divergence between short- and long-term yields highlights the continued flattening of the European yield curve.
Global Central Banks Drive Hawkish Market Repricing
European bond markets are also reacting to a series of major global monetary policy decisions.
The European Central Bank recently raised interest rates by 25 basis points to 2.50%, reinforcing expectations that monetary tightening may continue.
Attention has now shifted to the US Federal Reserve, which began its two-day policy meeting on Tuesday.
Interest-rate markets were pricing roughly a 90% probability of a 25-basis-point Federal Reserve rate hike, which would mark the central bank’s first increase since mid-2023.
Bank of Japan Expected to Raise Rates
The Bank of Japan is also expected to tighten monetary policy.
Markets broadly expect the BOJ to raise its policy rate by 25 basis points to 1.25% at its upcoming meeting.
If confirmed, the move would strengthen expectations of a coordinated global shift toward tighter monetary policy.
Traders Expect More ECB Rate Hikes
European swap markets suggest investors believe the ECB has not finished raising rates.
Traders are fully pricing in another 25-basis-point ECB rate increase before the end of the year.
Markets are also discounting the possibility of two additional rate hikes by February 2027.
These expectations are keeping pressure on short-term European government bonds.
Oil Prices Add to Inflation Concerns
Energy prices remain one of the main factors supporting higher bond yields.
Brent crude climbed above $113 per barrel, adding to concerns that higher energy costs could keep inflation elevated across Europe.
Saudi Arabia blamed Iran-backed forces for an attack on its East-West pipeline, raising concerns about possible disruptions to global oil supplies.
The pipeline carries volumes equal to roughly 4% of global oil supply, making any prolonged disruption potentially significant for energy markets.
Middle East Tensions Keep Energy Markets on Edge
Additional attacks by Yemen’s Houthis in the Red Sea have increased concerns over regional supply risks.
The postponement of transit negotiations in Oman has also added to fears that disruptions could persist.
Persistent oil supply concerns could keep inflation expectations elevated and strengthen the case for central banks to maintain higher interest rates for longer.
As a result, European sovereign debt markets may remain under pressure as investors continue to reassess the outlook for ECB monetary policy.
