By Geoffrey Smith
Investing.com -- Eurozone government bonds rallied hard on Wednesday, driving yield spreads across the bloc lower, as the European Central Bank confirmed reports that it is to hold an unscheduled council meeting to discuss recent volatility.
The yield on the benchmark Italian 10-Year bond fell 22 basis points to trade a fraction below 4%. It had risen above 4% for the first time since 2014 on Tuesday, as investors fretted about the ECB's first interest rate rise in a decade. The euro, meanwhile, rose 0.5% to $1.0470.
That brought the spread between the Italian and German benchmarks back down to 324 basis points, still an uncomfortably wide margin for the ECB, which tries to ensure that borrowing conditions across the currency union stay reasonably uniform. Spreads to other, weaker economies around the Eurozone periphery such as Portugal and Greece have also widened sharply in recent days, but followed the Italian lead on the back of the news.
Spreads had started to blow out on Thursday after ECB President Christine Lagarde had failed to give any detail about what it might do to stop what it calls "financial fragmentation." Ahead of the ECB meeting, various reports had suggested that the ECB was working on an "anti-fragmentation tool." As such, the lack of detail in Thursday's press conference came as a disappointment.
The selling had got worse since Friday as an overshoot in U.S. inflation in May drove investors to price in bigger interest rates in the U.S., too. The Federal Reserve is now expected to raise its key rate by 75 basis points when it announces its policy decisions at 2 PM ET (1800 GMT).
In a speech late on Monday, ECB board member Isabel Schnabel had already hinted heavily that the ECB felt the need to improve on its communication, as the renewed weakness in U.S. markets aggravated the situation closer to home.
"We will not tolerate changes in financing conditions that go beyond fundamental factors and that threaten monetary policy transmission," Schnabel said.
However, she too failed to give any more precise details about what the ECB is working on.
The Eurozone has faced two major episodes of stress in the last 10 years that have threatened to force one or more of its members out of the currency union. The first - the Eurozone debt crisis of 2010-2012, was effectively ended by a series of bailouts by governments and by a conditional promise of unlimited bond-buying from then ECB President Mario Draghi. The second, at the start of the pandemic, was addressed by a similar combination: the European Union expanded its abilities to issue debt jointly, while the ECB's 'Pandemic Emergency Purchase Program' for the first time explicitly gave it the freedom to tailor its bond purchases in favor of individual member states.
The ECB's problem with taking similar action this time around is that with inflation running at an all-time high of 8.5% in April, it has much less scope to add liquidity to the financial system.
"Details are needed to hold this performance," said Piet Christiansen, chief fixed-income strategist with Danske Bank, via Twitter, with an eye on Wednesday's bond rally.