Volatility In European Bond Markets Adds To Uncertainty In Global Markets

On top of too-hot inflation readings and fears of an economic downturn in most western nations, volatility in European bond markets is adding to the uncertainty gripping worldwide equity markets. Given how closely interlinked global markets are, rising European bond yields may further pressure U.S. and Canadian stock markets as the higher yields provide real competition for stocks.

U.K.: On October 10, the Bank of England (BOE) announced it would increase the amount of long-dated U.K. gilts it will buy above the 5 billion-pound daily pace it initiated in late September, but U.K.’s central bank also said it would end the purchasing program on October 14.

The BOE initiated the bond buying after the new U.K. government introduced a fiscal stimulus package that was poorly received by the financial markets (and has since been partially walked back), causing gilt yields to spike. In turn, many U.K. pension funds, which are large holders of the gilts, incurred substantial losses; some received margin calls. 

The BOE’s initial action caused yields to at least partially retrace, but they began increasing again, with the benchmark ten-year gilt reaching a 14-year high 4.39% yield on October 7. The October 10 action, which suggests the financial stress has not ended, caused yields briefly to move above 4.5% before closing at 4.46%. Another factor potentially contributing to the sell-off: disappointment that the BOE would no longer be a backstop gilt buyer after October 14.

Germany: Several media sources reported that new German Chancellor Olaf Scholz supports joint issuance of European Union (EU) debt — not individual country issuance by, in many cases, more indebted nations — to blunt the impact on customers from the roaring energy crisis on the continent. Germany’s share of the new debt would be supplemental to the amount it will have to borrow to fund its own 200 billion euro program to subsidize energy costs for German residential and business customers. In turn, the yield on the benchmark ten-year bund spiked to 2.35%, an 11-year high, from 2.20% on October 7.

Italy: Newly elected right-wing Italian Prime Minister Giorgia Meloni faces a mid-October deadline to submit a budget law to the EU. She campaigned on generous fiscal stimulus policies, including tax cuts and raising pension payments to Italians, but the EU will likely not accept any turning back on required fiscal reforms. Italy’s debt-to-GDP ratio is around 150%.

On October 5, the powerful credit rating agency Moody’s said that if PM Meloni were to deviate in any material way from the prior regime’s fiscally conservative path, it would downgrade Italy’s credit rating to “junk” status. This would likely force many institutional investors to sell Italian bonds, pushing yields much higher. Moody’s current rating for Italy is Baa3 with a negative outlook. Italy’s ten-year government bond currently yields 4.7%, about 235 basis points above Germany’s comparable bund yield. 

Italian ten-year government bond yield. Source: Trading Economics.

Information for this briefing was found via Trading Economics and the sources mentioned. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

Leave a Reply