German short-term yields are the highest since 2008

The yields on short-dated German debt reached their highest levels since the financial crisis on Friday as investors became more cautious about how high global interest rates would rise. The most since October 2008, when the collapse of American investment firm Lehman Brothers sparked a global crisis, German two-year rates, which are most sensitive to changes in interest rate forecasts.

10-year benchmark yields (DE10YT=RR) increased 5 basis points to 2.533%. Bonds are approaching pessimistic yield projection of 2.55%, but Citi strategists under Jamie Searle’s direction did not feel the need to increase it.

The ICE BofA-ML MOVE index, a measure of investor risk aversion that tracks bond market volatility, is on track to experience its greatest two-week gain since late November. While ‌ only slightly above its lowest level in nearly two years and still roughly 30% below October’s 32-month peak, February is proving to be a challenging month for fixed income.

Price pressures are unquestionably easing, according to data on inflation from the United States to the euro zone, Britain, Canada, and Japan. This is providing some respite to consumers who are stressed for cash.

Investors have to realize that interest rates may be approaching their peak, but that peak is higher than previously believed and rate decreases will take longer to materialize. But, it is proving to be persistent in less flexible sections of the economy, including as wages and the service sector. Based on what the market is doing, they might be underestimating it a little less than they were a few weeks ago.

German Rate cutting in 2023

A market-based measure of long-term inflation expectations in the euro zone rose to its highest level on Friday since May of the previous year. The five-year, five-year forward inflation swap, which basically measures where investors think inflation will be in ten years, soared above 2.4%, from closer to 2.3% a week earlier.

Money markets indicate that traders anticipate the ECB to continue hiking rates for the euro zone until about 3.75% by November of this year. In the last two weeks alone, the market has priced in an additional tightening of 50 bps.

Fabio Panetta, another board member who ING strategists refer to as an “arch dove,” stated on Thursday that smaller rate hikes wouldn’t necessarily result in a lower terminal rate, which helped fuel the sell-off in fixed income on that day.

The market pricing out the ensuing softening was something we saw more clearly yesterday. It has been reduced from roughly 100 bps before the ECB meeting to 80 bps from the (now higher) peak in 2023 to the end of 2024,” Antoine Bouvet of ING stated.

The result has been ‌severe damage to peripheral euro zone debt. Italian two-year rates have increased this week alone by more than a quarter of a percentage point.

The two-year yield on Italian debt pushed closer to its highest level since the summer of 2012, when the euro zone was grappling with a protracted debt crisis that required bailouts for Greece, Portugal, and Ireland, as well as extensive support for the banking industry in nations like Spain and Cyprus.

After rising from below 3% at the beginning of the month, two-year BTPs were last up 13 basis points at 3.554%, while 10-year yields increased by 14 basis points to 4.476%.