By Geoffrey Smith
Investing.com — Bond yields in the U.S. and Europe plunged on Monday as markets abruptly reassessed the outlook for central bank action in the wake of weekend bailouts for two big U.S. banks.
Market participants are betting that fears for financial stability will stop the Federal Reserve and the European Central Bank from raising interest rates further, even though inflation is still running well above the 2% targets of both central banks.
By 07:15 ET (12:15 GMT), the yield on the benchmark 3-month Treasury bill yield was down 30 basis points at 4.66%, effectively ruling out a rate hike from the Fed at its meeting next week. Until the problems at Silicon Valley Bank and Signature Bank (NASDAQ:SBNY) had become apparent, most people had expected the Fed to hike the fed funds target range by 25 basis points to 4.75%-5.0%.
At the same time, the 3-month German bill yield fell 17 basis points to 2.70%. The decline in euro yields was smaller because the European Central Bank has already guided very firmly that it will raise its key rates by 50 basis points each at its meeting on Thursday, taking its deposit rate to 3% and its refinancing rate to 3.5%.
“Massive central bank repricing of peak policy rates since Thursday,” said Danske Bank strategist Piet Haines Christiansen on Twitter. “Fed is 85bp lower and ECB is 74bp lower.”
While officials at both central banks have been adamant that further action is needed to tame inflation, many see them pedaling a softer line at least until it becomes clear that they have contained the fallout from the collapses of Silicon Valley Bank and Signature Bank. That seemed uncertain on Monday morning in New York, as stock prices of west coast banks in particular continued to fall sharply in premarket trading.
Marc Ostwald, chief strategist at ADM ISI in London, said that the Fed’s ability to constrain inflation with interest rate hikes “is now heavily encumbered by SVB’s collapse.”
“The scale of the fall in U.S. and other government bond yields is not a reflection of the risks that market attaches to the fall-out from the SVB collapse,” Ostwald said, “but rather a violent short squeeze on prior Fed rate hike bets, as well as the lack of underlying market liquidity.”
In both the U.S., the front end of the yield curve fell more sharply than the long end. While 2-year yields fell by some 50 basis points, the benchmark 10-year Treasury note fell only 22 basis points to 3.47%, while its German counterpart fell 30 basis points to 2.19%.