Headline inflation rose faster than expected in January, but at its slowest rate since late 2021, highlighting that the overall trend is heading lower, but price pressures are not easing quite as quickly as some had hoped. Treasury prices initially rallied, pushing yields lower on the day, before reversing course, prompting a similar reaction in euro zone debt. German 10-year yields were last up 2 basis points on the day at 2.391%, having risen by as much as 5.6 bps after the data. Benchmark 10-year Treasuries were last flat at 3.7206%, having ricocheted off a session low of 3.622% immediately after the inflation report to an intraday high of 3.759% around an hour later.
"The Fed have clearly said they need to see more evidence that (inflation) is coming down. I don't think they got that evidence from today's data, so I think it's clear they will continue hiking," Nordea chief analyst Jan von Gerich said. The spread between 10-year Bunds and 10-year Treasuries lurched to an intraday low of 121.13 bps immediately after the CPI report, before snapping back to around 133.18 bps - standing little changed on the day. Euro money markets have been steadily pricing in a higher terminal rate for the European Central Bank over the last week, since policymakers pushed back against expectations for interest rates to peak relatively soon. According to ECB euro short-term rate (ESTR) forwards, the ESTR will peak in September above 3.5%, up from a peak of 3.3% just two weeks ago. The ESTR published by the ECB reflects the wholesale euro unsecured overnight borrowing costs of banks. It is usually around 10 basis points (bps) below the deposit rate, so the 3.5% ESTR rate implies expectations for a deposit rate above 3.6%.
The short end of the curve is naturally more sensitive to shifts in expectations for interest rates. A jump in U.S. short-term rates has a knock-on effect on euro zone debt. Two-year Schatz yields hit a 14-year high of 2.815% and was last up 3 bps on the day at 2.812%. “We find an even stronger case for the repricing higher in European rates as the ECB is still behind the Fed in its fight against inflation,” ING strategists led by Padraig Garvey said in a note ahead of the inflation numbers. Italy’s 10-year yield rose by as much as 5 bps after the U.S. data before retreating to trade flat on the day at 4.186%, leaving the spread to German 10-year yields at 176.10 bps, roughly unchanged from where it was before the inflation report. (Reporting by Stefano Rebaudo, editing by Christian Schmollinger, Emelia Sithole-Matarise and Christina Fincher)
