EUR Rates Rise on Geopolitical Tensions, but Growth Worries Loom

The EUR rates continue to feel pressure from geopolitical headlines and rising oil prices. The 2-year Bund yield has returned to 3% after reaching peaks last week, indicating a potential increase in interest rates. However, it's essential to note that the impact of energy prices on EUR rates is not evenly distributed across the curve.

While the 2-year Bund yields have risen by 90 basis points since the start of the year, the 10-year yields have increased by around 55 basis points. Only 30 basis points of this increase can be attributed to rising inflation expectations, underscoring the exposed position of the eurozone.

Even without a rise in inflation expectations, the 10-year Bund yield would still be above 3.1%. The remaining increase reflects more resilient domestic growth expectations and a higher global term premium linked to rising actual and expected debt levels. A significant decline in long-end yields will require more than just easing geopolitics.

Disappointing economic growth could lead to lower interest rates, with the ECB's reaction function potentially changing quickly if growth disappoints. This could result in a dovish repricing of near-term policy rate expectations and a pullback in the neutral rate. A one-off inflation shock from oil should not have a lasting impact on the neutral rate.