Euro zone government bond yields largely dipped on Friday, but were still set for a weekly rise, as a rebound in energy prices prompted investors to assume the European Central Bank may need to deliver more than one additional rate hike this year.
Oil prices, which had fallen to their lowest since late February last week, have jumped nearly 13% this week, briefly hitting one-month highs above $85 a barrel, as the United States and Iran escalated attacks on one another in the Gulf, effectively closing the Strait of Hormuz.
A flurry of cooler U.S. inflation readings helped U.S. Treasuries outperform the rest of the global bond market this week. Two-year Treasury yields fell by the most in a month, dropping 8 basis points to 4.12% on Friday.
Given the European economy's greater vulnerability to imported energy, euro zone bonds have come under pressure, sending yields higher across the board this week.
Investors now see the ECB raising rates at least once more in September and attach a roughly 72% chance of a second hike before the end of the year. A week ago, they expected just one hike.
Still, economists believe two more hikes on top of June's are unlikely and some think a number of the big central banks, including the Federal Reserve and the Bank of England, will not raise rates again this year.
"As oil prices remain elevated, we could get more hawkish comments from the central banks. Our view still remains that we should not see any hike from the Fed, BoE or the ECB this year," Jefferies strategist Mohit Kumar said.
"Our pecking order of confidence is the BoE, Fed and the ECB. The lower confidence in ECB reflects the difference in mandate. While the Fed and BoE respond to both growth and inflation, ECB has a singular inflation mandate."
Longer-dated Bunds and BTPs also under pressure
Benchmark 10-year German Bunds have fared similarly poorly. The yield rose nearly 8.5 basis points this week to around 3.12%, almost matching the weekly increase in 10-year French bond yields, but trailing the 14-basis-point increase in Italian BTP yields.
German and Italian short-dated bonds lead weekly move
Two-year German Schatz yields rose 10 basis points this week and were trading at 2.77%, up 1 bp on the day.
That maturity is the most sensitive to changes in rate or inflation expectations. The premium the U.S. government must pay to borrow for two years over that of the German government has fallen to around 136 bps, its narrowest in two months.
"While oil prices still remain well below their latest highs, the damage at the front-end seems to be done," said Commerzbank strategist Hauke Siemssen.
Two-year Italian bonds performed the worst this week, with yields rising 15.3 basis points to 2.99%, given Italy relies more heavily on imported fuels than many of its neighbours.
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