European Bond Yields Surge as War Fears Push ECB Rate Hike to Full Expectation

European bond markets plunged on Friday as war-related risks intensified, forcing a complete reversal in expectations for the European Central Bank’s next policy move. The German 10-year bund yield rose to 2.87%, its highest level since late 2023, signaling that a rate hike—once considered a remote possibility—is now fully priced into the market. This shift follows a series of regional escalations that have disrupted energy flows and triggered capital flight from peripheral eurozone debt. The market’s recalibration reflects a broader reassessment of macro risks. With geopolitical uncertainty now central to monetary policy planning, traders have fully discounted an ECB rate increase at the upcoming March meeting, pricing in a 92% probability. This contrasts sharply with just two weeks prior, when the likelihood stood below 40%. The sharp adjustment has driven yields higher across the eurozone, with Italian 10-year yields reaching 4.31% and Spanish debt following suit. Financial markets have reacted swiftly: the VIX index climbed to 23.8, its highest since November 2024, indicating elevated volatility and risk aversion. Simultaneously, the euro weakened to 1.075 against the dollar, pressured by expectations of delayed rate hikes in the U.S. relative to the ECB. Energy stocks, particularly those in the defense and energy infrastructure sectors, saw gains as supply chain fears intensified. The repricing of bond yields has implications for fixed income investors, insurers, and pension funds holding eurozone government debt. Equity valuations, especially in long-duration and rate-sensitive sectors, are now under pressure. Market participants now view the ECB’s next move not as a policy choice but as a necessity to stabilize inflation expectations amid a backdrop of persistent supply shocks.