German 2-year yields drop from 19-month high, oil prices in focus

By Stefano Rebaudo

March 10 (Reuters) - Germany’s policy-sensitive 2-year bond yields slipped on Tuesday after touching a 19-month high the previous day, with investors pausing for breath after U.S. President Donald Trump said the war with Iran could end "very soon".

Euro zone government bonds have tracked moves in oil prices since early last week as the Middle East conflict fuelled expectations of rising inflation and potential tightening by central banks on both sides of the Atlantic.

Brent futures fell on Tuesday after hitting a more than three-year high in the prior session.

Iran's Revolutionary Guards said on Tuesday they would not allow "one litre of oil" to be shipped from the Middle East if U.S. and Israeli attacks continue, prompting a warning from Trump.

Germany's 2-year yields DE2YT=RR were down 5 basis points (bps) at 2.27%. They hit 2.476% on Monday, their highest level since August 2024.

Money markets priced in a 60% chance of a European Central Bank rate hike by July EURESTECBM4X5=ICAP and fully priced the same hike by year-end. EURESTECBM7X8=ICAP

Economists remain wary of an ECB tightening move, arguing that the bank has previously looked through oil-driven inflation spikes when higher energy costs also weakened the economy.

SOARING ENERGY PRICES

The soaring energy prices could fundamentally alter Europe's economic prospects but the ECB should take its time to reassess policy and stay on its present course for now, two policymakers said on Tuesday.

Germany’s 10-year government bond yield DE10YT=RR, the euro area’s benchmark, fell one bp to 2.85% after touching 2.931%, its highest level since mid-March last year.

"Fixed income markets are now pricing inflation permanence without the offsetting safe-haven demand, pushing yields higher on both sides of the Atlantic and, in the case of the ECB forward curve, implying outright rate hikes," said Jeff Blazek, co-CIO-multi assets at Neuberger.

"Given the genuine ambiguity around how long disruption lasts and whether higher energy costs prove transitory, that is a notably one-sided thesis, and one we are watching closely," he added.

Benchmark 10-year U.S. Treasury yields US10YT=RR dropped 0.5 bps to 4.13%.

"Supply shocks create tension between the Fed's mandates," said Aditya Bhave, U.S. economist at BofA.

"This 'fattens the tails' of the policy distribution: greater risk of an extended hold, tail risks of hikes, but also larger risks of deep cuts," he added.

Italy’s 10-year government bond yields IT10YT=RR dropped 8 bps to 3.55%. The gap versus Bunds tightened to 68 bps on Tuesday. It was at 63 bps before the conflict in the Middle East started.

Preference for Bunds widened yield spreads against government bonds of the most indebted euro area countries, such as Italy and France, although German bonds lost some of their shine as safe-haven assets.