Euro zone bonds calm, but investors hold on to rate-hike bets

Euro zone bond markets were calm on Monday following a surge in yields last week, though German bond yields still edged higher as investors held on to their bets for two rate hikes from the European Central Bank (ECB) next year.

At the ECB's policy meeting last week, president Christine Lagarde disappointed expectations of a firm pushback against the recent pricing of two ECB rate hikes next year that at are at odds with the bank's inflation projections.

The anxiety sent bond yields surging on Thursday and Friday, as investors saw the ECB as lacking confidence in its own outlook and started to focus on implication for the bank's bond purchases.

Markets were calmer on Monday, but some bond yields still rose and in a sign of caution, money markets held on to the rate-hike bets, still expecting a full 10-basis-point rate hike by July 2022 and two full hikes by October 2022.

Italy's 10-year yield briefly rose above Friday's levels to a fresh peak since July 2020 at 1.196%, but was flat at 1.17% by 0714 GMT. Other Southern European yields edged lower.

Germany's 10-year yield, the benchmark for the euro area, rose 5 bps to -0.10% but held below Friday's peak of -0.064%, which was the highest since May 2019.

Its 30-year yield, which fell sharply last week, rose 1 bp to 0.15%.

That steepened its yield curve as measured by the difference between 10- and 30-year yields slightly, though it was still near the flattest since March 2020 touched on Friday.

"Monetary policy tightening remains the key market focus as curve flattening dynamics remain intact," Rainer Guntermann, a rates strategist at Commerzbank said.

"There seems little respite in the coming week with ECB talk seemingly biased towards the hawkish side, the Fed (US Federal Reserve) likely to decide on tapering and the BoE (Bank of England) to start hiking rates."

Euro zone governments will bring this week around 20.5 billion euros of issuance to the market, and which will mostly be offset by a similar amount of flows from coupon payments and redemptions, according to Commerzbank.