Eurozone bond yields rise as upbeat data boosts Fed hike bets

Strong US economic report pushes up dollar

LONDON, Oct 3, (RTRS): Germany led a rise in bond yields across the eurozone on Tuesday as strong US data reinforced expectations of another interest rate rise this year by the Federal Reserve.

A pro-independence protest in Catalonia kept tensions between the wealthy Spanish region and the central government in Madrid in the spotlight, although Spain’s bond market was calmer after heavy selling the previous day after an independence vote on Sunday that was marred by police violence.

The overall mood across government bond markets was bearish as investors took their cue from upbeat economic data to sell fixed income and buy risk assets such as stocks.

The US Institute for Supply Management index, released on Monday, rose to 60.8 in September, from 58.8 in August, exceeding analyst expectations. The components of the index showed gains across the board.

That boosted expectations for another US rate rise this year, lifting the dollar. The euro, in turn, fell to a 1-1/2-month low just below $1.17.

A weakening in the single currency is seen as a headwind for bond markets since it could encourage the European Central Bank to press ahead with plans to unwind its massive stimulus scheme. The euro, up around 12 percent against the dollar this year, has complicated the ECB’s plans for exiting its stimulus scheme because a strong currency puts downward pressure on inflation.

Data on Tuesday showed eurozone producer prices rose a higher-than-expected 2.5 percent in August compared with a year earlier.

Most bond yields in the bloc were up 2-4 basis points on the day. Germany’s benchmark 10-year yield rose 4 bps to 0.49 percent, heading back towards 8-week highs hit last week after a tax plan from the US administration renewed reflation bets.

A public holiday in Germany, however added to subdued trade.

Two-year US Treasury yields hovered near 9-year peaks hit on Monday.

“People are still watching what the Fed is doing and in Europe, how the ECB will act,” said Benjamin Schroeder, senior rates strategist at ING.

Analysts said data on ECB bond buying, due out later in the day, would be scrutinised for signs on how close the central bank is to hitting its self-imposed limits for bond purchases.

A scarcity of eligible debt for quantitative easing is one reason why many economists anticipate ECB tapering in early 2018.

Spain’s 10-year yield was up 2 bps at 1.70 percent , but off highs seen in the wake of Sunday’s banned independence referendum in Catalonia.

The gap over German Bund yields narrowed to around 121 bps, having been at its widest level in around four months on Monday at around 126 bps.

“We don’t think tail risks from Catalonia will continue because this is a Spanish issue not a eurozone existential issue,” said Peter Chatwell, head of euro rates strategy at Mizuho.

Meanwhile, the euro bounced from a sixweek low on Tuesday as markets consolidated positions after a selloff, though investors grew cautious about the single currency’s outlook in the coming months on rising political uncertainty in Europe.

The unexpected outcome of the German election on Sept 24 and Sunday’s violencemarred independence referendum in the Spanish region of Catalonia has put the brakes on euro-bullish trades, with markets increasingly looking for the single currency to test the July lows of around $1.15.

“I think there’s a possibility, given what’s going on in Spain right now and given the fact Germany still doesn’t have a government and isn’t likely to get a government anytime soon, the political uncertainty is going weight on the euro,” said Michael Hewson, chief market strategist at CMC Markets.

A pro-independence protest in Catalonia on Tuesday kept tensions between the wealthy Spanish region and the central government in Madrid in the spotlight though Spain’s bond market calmed following heavy selling the previous day. Sunday’s independence vote was marred by police violence.

Still, the euro was partially supported by large option expiries on Tuesday that put a floor under the single currency. About $4 billion worth of currency options was expiring between the 1.1750 to 1.18 levels on Tuesday.

The euro bounced a quarter of a percent to $1.1758 and was trading above a $1.16955, a level it last hit on Aug 18.

Currency markets were also looking to add bets on possible divergence between the monetary policy outlooks in the United States and Europe, with expectations growing that the European Central Bank will adopt a more cautious stance.

“I don’t think the market is pricing how cautious they are likely to continue to be and that will be reiterated by (European Central Bank chief) Mario Draghi on Wednesday,” said Martin Arnold, a macro-strategist at ETF Securities in London who expects the euro to weaken against the dollar.

Meanwhile, the dollar climbed for a second consecutive day as a strong reading for US manufacturing activity pushed bond yields higher, prompting investors to trim some of their extreme short bets against the greenback.

As anticipation of a US rate increase spread to more than 71 percent by December from 42 percent a month earlier, according to the CME’s Fedwatch indicator, the dollar has rallied more than 3 percent over the last month.

The dollar climbed 0.2 percent to 93.74 against a broad basket of currencies, its highest level since Aug 17. Despite its recent gains, the dollar is down more than 8 percent this year, on track for its biggest annual decline in a decade.

The dollar’s surge put the pressure on carry trade currency favorites such as the Aussie and the New Zealand dollar , which were down by more than 0.3 percent each.

The Australian dollar fell to its lowest in more than two months after the Reserve Bank of Australia left interest rates unchanged and gave a cautious assessment of the local economy.