Europe's bond rout is outpacing other major markets. Over the past month, longer-term borrowing costs in France, Italy and the UK have climbed the most in the G7, pushing yields to multi-year highs.
Germany hasn't dodged it. Investors are asking for the richest compensation since 2011 to hold its 30-year bonds. On the 10-year point, bund yields have climbed by 24 basis points from Aug. 4, reaching roughly 3.35%. The comparable US Treasury is up 14 basis points over that window.
Futures imply the ECB will deliver three additional quarter-point rate hikes over the next year, with the first anticipated at Thursday's meeting. For the US, markets price two hikes over the same period.
Natural gas is steering the story. Since the Iran war began, prices have jumped over 120%, reaching a three-year high last week. Storage is at a record low for this time of year, raising the odds of a last-minute scramble to refill before winter. After sitting out the summer, governments and companies could reenter the market and push prices above €100 per megawatt-hour, about 40% above current levels.
That backdrop is feeding fears the ECB will have to keep tightening. A market-based read on euro-area inflation for the next 12 months is back to levels last seen in May. "Europe's energy dependence is back in focus," noted Ludovic Subran.
He is Allianz SE's chief investment officer as well as its chief economist. He said rising inflation expectations have lifted where investors think policy rates will sit, helping drive longer-dated yields higher.
"Europe is particularly exposed to a gas spike," said Mark Dowding, RBC Bluebay Asset Management's chief investment officer. "The reality is that poorer developing countries can't pay up and Europe essentially outbids them."
In the US, oil is the bigger inflation swing factor and is still about 20% below its April peak, a split that shows up in bond moves. Even if Washington and Tehran succeed in bringing back the peace agreement that fell apart in July, central banks remain wary of second-round effects as energy costs ripple through the economy. A "Super El Niño" in the coming months could also lift food inflation.
Budget season for 2027 is colliding with rising spending pressures and election calendars, and traders are watching closely.
France has lagged. Would-be successors to President Emmanuel Macron next year are offering sharply different plans to tackle a large debt load and a deficit above 5% of GDP. The extra yield investors demand to own French bonds over German bunds is near its widest since the euro area's 2012 debt crisis.
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Italy is the contrast. Its borrowing costs have narrowed versus Germany's, a sign investors view Prime Minister Giorgia Meloni as bringing steadier politics and tighter fiscal discipline. She leads the longest-serving government since 1946 and faces an election next year.
Davide Oneglia, who is TS Lombard's director for European and global macro, warned of one risk: that she teams up with a new far-right party, creating a shakier coalition that skews more populist. "There are good reasons to think the market is not paying enough attention to political dynamics in Germany and Italy, leaving it exposed to 'bad surprises' and sudden repricing of risk/term premia when news hit the wire," he said.
Germany has its own flashpoints. Business leaders warn about rising populism after the Alternative for Germany won in Saxony-Anhalt on Sunday, posting its strongest result there to date, yet ending up three seats short of controlling the state legislature. Chancellor Friedrich Merz, already dealing with internal discontent in his conservative bloc, is under increasing pressure.
Bloomberg strategist Conor Cooper notes little immediate macro or fiscal impact even if AfD took state power, but says the reputational hit matters for bunds. Germany's safe-haven status rests on political stability, and although German 10-year yields have increased by less than most peers since the Iran war began, an AfD-led state could change that perception.
Rabobank's Michael Every says markets may be staring at a second structural shift, after Germany moved from strict fiscal limits to looser debt rules to fund major defense and infrastructure. "First, 'Germany will never borrow' became 'Germany is borrowing hugely'; could 'Germany is politically stable' now become 'Germany is politically unstable'?" he wrote. "We are looking at a possible near future where populists are no longer the angry minority but the majority," he added.
Higher yields are tempting some buyers back in. Steve Ryder, a senior portfolio manager at Aviva Investors, has been increasing European exposure while hedging inflation risk due to energy's unpredictability. Kevin Zhao, who runs UBS Asset Management's division for global sovereign fixed income and currencies, has been purchasing long-dated German notes.
Plenty of this is global. Resilient US growth has weighed on Treasuries, and a capital tug-of-war amid heavy bond issuance from governments and tech firms is in the mix. David Zahn, who heads European fixed income at Franklin Templeton, says external forces account for a large share of Europe's move.
He is "pretty close" to buying longer-dated bonds, but wants the German 10-year nearer 3.5% first. "Global yields are rising and so Europe is not immune to that," he said. "I don't know what it's going to be to just stop yields rising."
For your wallet, the takeaway is straightforward: in Europe, gas prices, politics and global crosswinds are setting the level on government yields. If gas keeps stealing the spotlight, it will keep steering the story.
