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Euro zone government bond yields teeter in thin, choppy trading

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LONDON — Euro zone government bond yields seesawed on Thursday in volatile trading, as investors weighed up how a more hawkish interest-rate outlook and higher supply next year will impact the broader fixed-income market.

Yields on German 10-year Bunds, which serve as the benchmark for the broader euro zone, were up 1 basis point at 2.51%, while two-year yields were up 1 bp at 2.68%, leaving the gap between the two, or curve, at -16 bps.

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The German yield curve has been inverted for the better part of a month, as investors have priced in the prospect of the European Central Bank taking a tough line on inflation and raising interest rates quickly to control it.

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Trading has been more volatile than usual this week as thin volumes exaggerated price fluctuations.

Average daily volumes in Bund futures are down by about a quarter from last week and down almost 50% on where they were a month ago, according to Refinitiv data.

“It’s always tricky reading too much into market moves at this time of year, because liquidity is dire, and the slightest random flows can cause big market moves,” Mike Riddell, senior portfolio manager at Allianz Global Investors, said.

German Bund yields have risen by over 250 bps this year, their largest annual increase since at least the 1950s, not least because of the steep rise in interest rates and inflation.

European governments are funneling cash into schemes to help consumers and businesses deal with energy prices, which have rocketed this year, driven mainly by a collapse in Russian natural gas deliveries to the region.

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To fund those initiatives, sovereign issuers must raise billions in new debt sales. Germany alone plans to issue a record 500 billion euros next year to cover costs linked to the energy crisis and the recovery from the pandemic.

With these two factors in mind, there are two main drivers for yields right now, according to Jussi Hiljanen, who is chief European rates strategist at SEB.

“One: a hawkish ECB – an aggressive message at the December meeting; a very high inflation trajectory; a relatively optimistic growth forecast; upcoming reduction in securities holdings and two: a dramatic change in supply prospects in 2023 (massive increase in net issuance adjusted for ECB purchases),” Hiljanen said.

Around the periphery, Italian two-year yields rose 3 bps to 3.233%, while 10-year yields fell 1 bp to 4.639%.

Spanish Bonos were flat at 3.587%, while Greek yields eased 1 bp to 4.578%.

UK gilt yields, which have swung from lows of 0.946% to highs of 4.632% in their most volatile year since 1982, were up 5 bps at 3.711% – near two-month highs. (Editing by Tomasz Janowski and Chizu Nomiyama)

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