The gap between German and US 10-year borrowing costs moved to roughly its narrowest level in about a month on Thursday as fresh fighting in the Gulf lifted euro-zone yields, while softer US inflation data restrained moves in US Treasuries.
Germany's 10-year bund yield climbed to 3.13%, up 1 basis point on the day and marking its highest reading since May 20. The German yield has advanced 9 basis points so far this week and is up 26 basis points in July to date. Market participants said the renewed hostilities between Iran and the US in the Gulf have raised concerns that oil and gas prices could resume an upward path, a development that could both stoke inflation and prompt the European Central Bank to take a more aggressive stance on rates, while also creating drag on longer-term economic growth.
By contrast, the 10-year US Treasury yield stood at 4.56%, 2 basis points higher on the day, flat for the week and 14 basis points higher on the month. Traders have trimmed expectations for near-term Federal Reserve tightening after recent consumer and producer inflation prints came in cooler than anticipated.
The spread between the German and US 10-year yields was last about 144 basis points, near its narrowest level since early June. That compares with a peak near 157 basis points in late June, when European government bonds had rallied on signs that oil and gas flows through the Strait of Hormuz might resume and when markets were pricing a higher likelihood of imminent Fed hikes.
Market pricing currently implies roughly a 90% chance of an ECB rate increase by the central bank's September meeting. If such a move occurs, it would be the ECB's second rate rise this year following its June hike, and markets also see a good chance of a third rate move by the end of the year.
Analysts and traders following the moves highlighted the divergent exposures of the two economies to energy from the Gulf, noting that the United States is less exposed than Europe. That differential is a key factor in why euro-zone yields have been more sensitive to the escalation in Gulf tensions, whereas US yields have reflected both the geopolitical backdrop and the recent softer inflation readings that have moderated expectations of rapid Fed tightening.
The combination of rising euro-area yields, persistent concerns about energy-driven inflationary pressures, and tempered Fed expectations has left the bond market with a narrower bilateral yield gap than seen at the end of June, when developments around the Strait of Hormuz and changing rate expectations drove larger swings.