European markets "in panic": US bond storm spreads, European bonds face "Black Thursday"

The global bond market sell-off is spreading from U.S. Treasuries to Europe, with European government bond yields surging and spreads widening rapidly, as concerns over a new round of debt risk rise significantly in the market.

European bond markets experienced a sharp sell-off on Thursday, with the French 10-year government bond yield once rising to 4.96%, the highest since 2002; the France-Germany spread widened to 1.4 percentage points, and Italian and Greek government bond yields also moved higher. The UK 30-year government bond yield broke above 6% for the first time. Meanwhile, the U.S. 10-year Treasury yield climbed to as high as 5.34%, the highest in nearly 24 years, before retreating to 5.24%.

Columbia Threadneedle portfolio manager Ed Al-Hussainy warned that the market is "giving off faint signs that a crisis is brewing."

This round of sell-off was mainly driven by renewed inflation and interest rate expectations. The Middle East conflict pushed up energy prices, with Brent crude rising by 4.4% on Thursday to $102.31 per barrel. At the same time, strong U.S. economic data exacerbated market fears of interest rates staying higher for longer. Europe’s own fiscal pressures and forced deleveraging of highly leveraged hedge fund positions further amplified the volatility.

The sharp volatility in the bond market has also dragged down risk assets. The pan-European Stoxx 600 index fell 1.3%, the FTSE 100 dropped 1.7%, European bank stocks came under significant pressure, and the euro fell to its lowest level in over a year; U.S. equities were relatively resilient, with the S&P 500 index rising 0.2% and the Nasdaq 100 up 0.3%.

U.S. Treasury yields touch 25-year highs, "vicious cycle" warnings emerge

The U.S. 10-year Treasury yield rose as high as 5.34% intraday on Thursday, the highest in 24 years, before falling back to finish at 5.24%, down 5 basis points from the previous session.

Rob Subbaraman, Global Head of Macro Research at Nomura, stated that the recent scale of government bond selling has "stunned" traders, as higher inflation expectations and concerns about government deficit sustainability have pushed yields further up.

Mike Bell, Head of Market Strategy at RBC BlueBay Asset Management, pointed out that a large number of investors are being forced to stop out or are choosing to unwind positions as yields continue to rise, causing the market to fall into a "vicious cycle."

However, following the sharp sell-off in European bonds, U.S. Treasuries instead saw safe-haven buying. Izaac Brook, U.S. Rate Strategist at RBC Capital Markets, said that the market focus has shifted from U.S. fundamentals to overseas yields, with investors seeking "safe assets" and driving flows into U.S. Treasuries.

The pressure in the bond market is also starting to transmit to the real economy. Data from Freddie Mac show that the average 30-year fixed mortgage rate in the U.S. rose this week to 7.28%, a jump of 25 basis points in a single week, marking the largest weekly increase in four years.

French budget fails to boost confidence, political risks increase bond market pressure

France has become the core of this round of European bond market volatility. The intraday swing in the French 10-year government bond yield reached 16 basis points, double its average daily range; the France-Germany spread widened to 1.4 percentage points, the highest since the European debt crisis.

The French government unveiled its 2027 budget plan on Thursday, aiming to cut spending by about 43 billion euros and raise taxes to bring the fiscal deficit down to 5% of GDP. However, the market reaction remained muted. ING rates strategist Benjamin Schroeder said, the market had expected a budget reflecting fiscal consolidation efforts to elicit a more positive response, but "the market skipped right past it."

TS Lombard economist Davide Oneglia noted that French polls indicate a rise in support for far-left candidate Jean-Luc Mélenchon in next spring’s presidential election. Mélenchon previously proposed cancelling part of France’s government debt held by the central bank, a stance that has now become a "green light signal" for investors shorting French government bonds.

Hedge fund forced liquidation amplifies European bond market volatility

According to The Wall Street Journal citing traders, the current European bond market turmoil has been greatly amplified by the forced deleveraging of hedge funds.

For years, a large number of investors including hedge funds have poured into the French government bond market, profiting from the price difference between bonds and related interest rate swap products. These trades are highly leveraged and require bond yields to remain relatively stable. As yields continued to climb, these positions have been unwound over recent weeks, with Thursday seeing especially intense liquidations.

Blake Gwinn, Head of U.S. Rates Strategy at RBC Capital Markets, noted that there are several "quite crowded" popular trades in the European bond market and "all of these structural positions have taken losses."

With liquidity in French bonds drying up, investors shifted to selling Italian and Greek bonds, spreading risk to other European bond markets and sparking renewed fears of a eurozone debt crisis-style contagion. TD Securities rates strategist Pooja Kumra said the volatility is "already quite pronounced" and policymakers need to send clear intervention signals.

Igor Yelnik, founder of Alphidence Capital, warned that current hedge fund leverage is higher than the last time yields were at similar levels, which could further contribute to a vicious cycle.

Bond market selling pressure spreads to credit markets, ECB rate hike expectations cool off

The impact of bond sell-offs is also beginning to spill into corporate credit markets. ICE BofA data show that the spread between European investment-grade corporate bonds and government bonds rose this week to approximately 90 basis points, the highest since April this year.

Andrew Jackson, Head of Investments at Vontobel Asset Management, said the risk of credit spreads widening further is growing as government bond yields move higher.

Meanwhile, policy pressure is mounting on the European Central Bank. On Thursday, investors slashed bets on future ECB rate hikes, with current market pricing pointing to less than three hikes over the next year.

Guy Miller, Chief Market Strategist at Zurich, summed up the current global bond market linkage: "As yields move higher, all markets are pulling each other along."