Euro zone government bonds snapped a three-day rally on Wednesday, responding to a rise in oil prices as attacks in the Middle East flared up again, while an upcoming U.S. Federal Reserve rates decision also kept bond traders on edge.
The price of the euro zone benchmark, the 10-year German Bund, dropped, sending its yield up 1 basis point to 3.12%. The yield had fallen for the past three sessions from its 15-year high of 3.212% reached on July 23.
Since the war in the Gulf began in late February, European bonds have largely traded in response to the state of the conflict, and particularly moves in oil and gas prices.
Policymakers are closely watching whether higher energy prices will spill over into broader inflation and require them to raise interest rates more aggressively. As attacks intensified and Iran rejected regional joint management of the Strait of Hormuz on Wednesday, scuppering hopes for a resolution to the impasse that has choked off Gulf trade for months, Brent crude rose 3.5% to $87 a barrel, sending European yields higher.
While oil was the focus for bond traders even on the day of last week's European Central Bank meeting, Wednesday's Fed decision could be the one thing to draw attention away from the Gulf.
Markets expect the Fed to remain on hold but see a roughly 30% chance of a hike, and that possibility is keeping investors nervous.
"This is the most uncertain that the market has been on whether the Fed will change rates going into a meeting since December 2018," Jim Reid, global head of macro research at Deutsche Bank, said in a morning note.
Other euro zone bonds were slightly underperforming the German benchmark. Italy's 10-year yield rose nearly 3 bps to 3.94%, and France's rose 2 bps to 3.91%.
Shorter-dated yields also rose more, with Germany's two-year yield up 3 bps at 2.76%.
