Geopolitical Tensions Impact Eurozone Bond Yields

Germany's policy-sensitive 2-year bond yields saw a decline on Tuesday following a 19-month high reached the day before. This comes as investors tempered their reactions after U.S. President Donald Trump indicated that the conflict with Iran might soon de-escalate.

The euro zone's government bonds have been reacting to fluctuations in oil prices, driven by the Middle East tensions that have heightened inflation expectations and potential rate hikes by central banks. Notably, Brent futures dropped after touching a high not seen in over three years. Iran's Revolutionary Guards have threatened to halt oil shipments if attacks persist, drawing a retort from Trump.

Germany's 2-year yields, aligned with policy rate expectations, fell by 3 basis points to 2.29%, after spiking to 2.476% on Monday - a peak since August 2024. Money markets suggest a 60% probability of a European Central Bank rate hike by July, rising to 85% by the year-end. Despite previous energy cost-driven inflation surges, the ECB remains cautious about tightening. Meanwhile, Italy's 10-year bond yields fell, narrowing the yield gap versus Bunds amid mixed responses to safe-haven assets.