Euro-area sovereign bond yields moved higher on Monday following an escalation of tensions in the Middle East that pushed oil prices up and prompted fresh questions about a recent interim agreement between Washington and Tehran.
The immediate market reaction followed military exchanges between U.S. and Iranian forces and an announcement from Tehran that it had closed the Strait of Hormuz again. Those developments cast doubt on an interim U.S.-Iranian accord agreed last month, which had been intended to reopen the strait and to bring an end to the Middle East war after 60 additional days of negotiations.
Bond yields and oil
Germany's 10-year government bond yield, the benchmark for the euro zone, climbed 3.8 basis points to 3.0726% on Monday. That followed a roughly 10 basis-point increase in the prior week, which was the largest weekly rise since early June. Markets said the latest uptick in yields reflected heightened uncertainty about the prospects for regional peace and the implications for inflation and interest rates.
Shorter-dated German yields also rose. The 2-year yield increased 6.6 basis points to 2.7149% after earlier touching 2.72% in the session - its highest reading in a month. The 2-year had posted its largest weekly gain since early June in the previous week, rising by 11 basis points.
Energy markets moved in step. Brent crude futures rose 4.3% to $79.32 per barrel on Monday. That price placed Brent above pre-war levels, though it remained well below the peaks seen in April.
Monetary policy expectations
Money market pricing shifted to reflect a somewhat firmer expectation of European Central Bank tightening by year-end. Markets were pricing in approximately 37 basis points of additional tightening from the ECB by the end of the year. In effect, that implies one more quarter-point interest rate increase and roughly a 50% probability of a second hike. The implied chance of an additional hike was slightly higher than it had been on Friday.
Market context
Before the recent flare-up, concerns about the economic outlook had been easing amid hopes for a negotiated resolution to the conflict and for lower energy costs. The renewed tensions, and the associated rise in oil prices, have reintroduced uncertainty into assessments of inflation dynamics and central bank policy paths, contributing to the rise in bond yields across maturities.