Germany's two-year yield , which is the most sensitive to changes in interest rate expectations, was last up 26 basis points (bp) at 2.58%, in its biggest daily jump since September 2008, during the global financial crisis.
It hit a 14-week low of 2.089% on Monday.
Bond yields move inversely with prices. On Sunday, the Fed and five other major central banks, including the European Central Bank, took coordinated action to bolster dollar liquidity throughout the global financial system with a new daily currency swap facility.
Euro area banks have borrowed just $10 million from the ECB's facility in the two operations since Monday, providing reassurance that banks in the bloc have no pressing need for extra dollars.
"The lack of demand ... probably triggered the relief, highlighting that dollar liquidity provision is not seen as the problem at the moment," Commerzbank rates strategists said in a note.
Expectations for interest rate increases have picked up marginally, after bets were scaled back over the last two weeks for how far the ECB might raise rates. On Monday, ECB President Christine Lagarde said market turmoil may dampen demand and inflation but that interest rates would still be the main tool to fight rising prices.
The August 2023 ECB euro short-term rate forward was around 3.275%, implying expectations for a deposit rate peak at 3.375% by then. It rose as high as 3.3% after falling below 3% on Monday. The November 2023 forward had peaked above 4% before fears of a banking crisis started to hit markets on March 9. "We have seen the market over-interpret what the ECB is going to do in both directions," said Daniel Lenz, head of euro rates strategy at DZ Bank.
"With no negative news flow, I would expect markets to begin pricing in further rate hikes. The market is pricing just one step at the moment and that is far too low," Lenz added.
Germany's 10-year yield , the benchmark for the euro area, was last up 18 basis points (bps) at 2.268%, in its biggest rise since March 2020. It hit more than a 13-week low of 1.923% on Monday.
Italy's two-year yield was up 12 bps at 2.99%.
Italy's 10-year yield rose 13 bps, pushing the closely watched 10-year yield gap between German and Italian bonds to 181.9. The spread hit a one-week low at 179.2 earlier in the session. The focus shifted to the Fed's policy announcement on Wednesday, with markets split on whether the U.S. central bank will raise its benchmark policy rate. Fed funds futures price in more than an 80% chance of a 25-bp rate rise, with just under a 20% probability of no change. Two weeks earlier, market pricing suggested a 50-bp rise was the most likely outcome. <^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ German 2y ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^> (Reporting by Samuel Indyk; editing by Barbara Lewis and Paul Simao)
