The news of Silicon Valley Bank’s (SVB) collapse caused a shock wave to the bond markets of the Euro area this week. Investors scrambled to safe-haven assets such as government bonds as they assessed the implications of the bank’s failure.
At the same time, the Federal Reserve is widely expected to keep its monetary policy loose. This has further weakened the U.S. Dollar, providing an additional tailwind to Euro-denominated bonds.
Government Bond Yields Plunge As Crisis Emerges Following SVB Failure
On Monday, the yields on government bonds went down as people rushed to acquire safe-haven assets. This occurs while evaluating the potential effects of SVB’s failure and due to speculation of the U.S. Federal Reserve’s lesser aggressive tightening.
U.S. authorities on Sunday activated emergency protocols to bolster trust within the banking structure following the failure of SVB, which could have caused a more comprehensive economic crisis. According to a high-ranking source, the European Central Bank has yet to make plans to convene its financial oversight committee in response to the collapse of SVB.
As a result, European stocks took a plunge on Monday, on track for their worst day in almost three months, with banking stocks the most affected. On Sunday, Goldman Sachs analysts suggested that the Federal Reserve is unlikely to raise interest rates at its March 22 meeting due to the recent upheaval in the banking sector.
Furthermore, the analysts indicated considerable ambiguity about what will happen beyond this month. The U.S. 2-year Treasury yield plummeted by 41 basis points to 4.17%, its most notable 24-hour decrease since 2008 and its most minor level since February 3 (4.157%).
Meanwhile, Germany’s 2-year yield plummeted by 40 basis points to 2.68% and touched its most minor since February 9 (2.584%). This was its most extreme daily decrease since January 1995.
Yields with a shorter duration are exceptionally responsive to modifications in the anticipated policy rate direction. As George Saravelos, global head of foreign exchange at Deutsche Bank, mentioned, this implies that the Federal Reserve must make a robust case to resume a tightening trend.
Traders Lower Expectations For Fed’s Rate Increase
Futures for the Fed Funds rate indicated that traders lessened their expectations for the Fed’s potential rate increase. Despite this, markets still believe there is less than a 50% probability of a 25-basis point rate hike next week.
The June 2023 Fed Funds futures contract went up to 95.15 basis points, predicting a terminal rate of 4.85% by the summer, up from 94.5 basis points the previous Thursday with a rate of 5.5%. The demand for safe investments such as long-term bonds multiplied, decreasing 25 basis points on Germany’s 10-year yield to 2.246% – the lowest since February 6.
Italy’s 10-year yield also dropped 17.5 basis points to 4.15%. The news of SVB’s collapse has added to the risk-off sentiment in the bond markets, causing Euro area bond yields to tumble.
