The European bond market is experiencing its steepest selloff among major economies in recent weeks, driven by spiraling gas prices and escalating political risks. Longer-term borrowing costs in France, Italy, and the UK have seen the largest increases within the G7 over the past month, with yields reaching multi-year highs. Even Germany, traditionally a safe haven, has been affected, with investors demanding the highest compensation since 2011 to purchase its 30-year debt. This widespread bond market stress is making it more expensive for consumers to obtain mortgages, for businesses to borrow, and for governments to manage their debts.
Energy prices are a significant factor, with natural gas prices up over 120% since the Iran war began, reaching a three-year high last week. Diesel prices, crucial for transportation and manufacturing, have surged 51% since the war started and are 90% higher than pre-war levels. This energy price inflation is exacerbating worries in the bond market and prompting central banks to consider further interest rate increases. The European Central Bank is widely expected to raise rates to 2.5% this week, with a 75% probability of another hike to 3.0% by December. The Bank of Japan is also anticipated to raise rates by a quarter point on September 18, with a 60% chance of a subsequent move by December. In the US, the Federal Reserve faces a 58% chance of a hike at its September 16 meeting and 70% for an October move, following stronger-than-expected payroll reports.
Political instability in Europe is also contributing to market anxieties. In Germany, the far-right Alternative for Germany (AfD) recently secured a strong win in state elections in Saxony-Anhalt, raising concerns about populism and the potential impact on Germany's safe-haven status. In France, polls suggest that far-right leader Marine Le Pen, who has previously advocated abandoning the euro, could win the first round of next year's presidential elections. These developments, along with rising oil prices and conflict in the Middle East, have left the euro as the weakest performing major currency against the dollar this year, falling 1.1%. While some investors are finding higher yields tempting, analysts like David Zahn of Franklin Templeton note that global factors are also driving Europe's bond market movements, and stopping the rise in yields will be challenging.
