The sell-off in euro zone bonds stopped on Tuesday, with yields falling from their highest levels in years, but remaining near high levels, on expectations that strong growth and rising energy costs will push global interest rates higher.
The 10-year German government bond yield, the euro zone's benchmark, fell by two basis points to 3.625 percent, after rising on Monday to 3.6526 percent, its highest level in 17 years. Bond yields move in the opposite direction to their prices, according to Reuters.
The benchmark yield in the euro zone recorded its first decline in six sessions, at a time when oil and gas prices are still the main driver of the bond market, amid fears that inflation caused by high energy costs will push the European Central Bank to continue raising interest rates.
European Central Bank President Christine Lagarde said that the bank believes that adopting a deliberate and calculated response is the most appropriate option to control inflation. She added that developments in the bond market, especially rising long-term yields, may lead to a slowdown in economic growth.
“We estimate that this means one or two additional increases in interest rates from this stage,” Danske Bank economist Olavi Kaskesaari said.
He added: “This also means that the European Central Bank is in no hurry to raise interest rates again, which reduces the possibility of the next increase in October.”
Financial markets are currently pricing in four additional interest rate increases, at a quarter of a percentage point for each increase, in addition to the two increases approved over the summer.
The two-year German bond yield, which is most sensitive to changes in the European Central Bank's interest rate expectations, also fell by about two basis points to 3.281 percent, after hitting its highest level in three years the previous day.
Saudi Arabia is heading into an economic phase in which geopolitical transformations intertwine with rapid developments in artificial intelligence, energy, and the labor market, at a time when the abundance of information does not necessarily mean ease of decision-making, with the increasing need to sort out variables and identify the most influential trends in the economy and investment.
At the opening of the first edition of the “Servcorp Economic Forum” in Riyadh on Tuesday, Walid Abu Khaled, Chairman of the Board of Directors of Emer for Emerging Markets Intelligence and Research, said that challenges will remain, but what is more important is how to deal with them and turn them into opportunities, pointing out that the challenges facing Saudi Arabia and the world today differ in nature from those that existed in previous decades.
Abu Khaled pointed out that the geopolitical developments related to Iran, the United States, and Israel, in addition to the security of the sea lanes in the Straits of Hormuz and Bab al-Mandab, highlight the importance of Saudi Arabia’s position in the global economic system, especially in the energy sector, describing the Kingdom as “the heart of the global economy” when it comes to energy that fuels the movement of the global economy.
In parallel, he said that artificial intelligence imposes a profound transformation on the labor market, with the acceleration of automation and the use of new technologies in the manufacturing, consulting and programming sectors, raising increasing questions about the jobs and skills that the economy will need in the future.
He pointed out that companies in the robotics sector are moving towards fully automated factories, while he pointed to the use of artificial intelligence in implementing a large proportion of consulting and programming work, considering that technical transformation affects various aspects of the economy, and makes issues of human capital and future skills a major part of the economic discussion.
Saudi Arabia and its global role
For his part, David Godchaux, CEO of the Middle East, Europe and America region at Servcorp, said that Saudi Arabia has witnessed a major transformation over the past 17 years, during which it moved from an emerging market to a major economy in the region, with its growing role at the global level.
He explained that the ease of obtaining information today does not mean that decision-making has become easier, as the amount of available information has increased significantly due to artificial intelligence, social media, and geopolitical developments, which has made the challenge represented in identifying valuable information from among this increasing quantity.
Godchaux added that the “signal to noise ratio” has declined, which increases the need for spaces that bring together business leaders, investors and policy makers to exchange information and read economic trends jointly, noting that the goal of the forum is to find “the signal in the midst of all this noise.”
According to Godchaux, the transformation witnessed by Saudi Arabia has made the economy more diversified, and energy is no longer the only driver of its importance, as the geographical location of the Kingdom and the network of paths that connect it to the rest of the world constitute additional factors that will increase in importance in the coming years.
Flexibility of capital in the face of transformations
Godchaux stressed that the upcoming opportunities require companies and investors to have a greater degree of flexibility and speed in directing capital, whether towards infrastructure projects or attracting the competencies and resources necessary for growth, stressing the importance of making decisions based on reliable and analyzable information.
The Servcorp Economic Forum, which brings together about 150 senior business leaders, investors and policymakers, focuses on the variables that are reshaping the economies of Saudi Arabia and the Middle East, North Africa and Turkey region, including artificial intelligence and productivity, energy and infrastructure, capital channeling, international trade, and the impact of technology on the labor market and future skills.
The forum comes at a time when Saudi Arabia continues to implement the goals of “Vision 2030”, while participants discuss economic transformations from a five-year perspective, with a focus on how to link global changes to the practical decisions of companies, investors and policy makers in the region.
The euro, which is trading near its lowest levels this year against the dollar, faces a double test from a global shock in energy prices and rising political risks in Europe.
The euro was heading towards the $1.20 level in August, but it fell by about 2 percent during September, reaching its lowest levels in two months, just below $1.14, according to Reuters.
While the rise in US interest rates, which reaffirmed the Federal Reserve's hawkishness in combating inflation, strengthened the dollar, the euro's prospects became more uncertain due to political developments in Europe and a renewed rise in oil prices, which may put pressure on an economy that has so far shown more resilience than expected.
Jane Foley, chief currency strategist at Rabobank, said: “How long can this economic resilience last? Can it really last through the winter? Then we enter the spring, and we may face a turbulent political scene.”
In Germany, Chancellor Friedrich Merz is facing the repercussions of the success achieved by the far right in the recent regional elections, a surprising development that may prompt him to ease the reform agenda he pledged. In France, markets are under pressure due to concerns about high public debt and political deadlock, with the presidential elections scheduled for 2027 approaching.
“I'm a little concerned about the euro in this environment,” Foley said, adding that her prediction that the euro/dollar rate would reach $1.16 within three months is currently under review.
The premium required by investors to hold French government bonds for 10 years, compared to German bonds rated “EEE”, has risen to more than 110 basis points, in a worrying sign for the euro.
Currency strategists at Bank of America estimate that every additional 10 basis point widening in this gap is associated with a decline of about 0.4 percent in the euro against the dollar.
The euro was last trading at about $1.137.
Options markets have also become more pessimistic towards the single European currency. Three-month “risk reversal” contracts for the euro, which reflect the difference between the prices of options used to buy the currency and those used to sell it, recorded their largest weekly decline since the outbreak of the Iran war last week.
High prices increase pressure on the euro
Although analysts and investors see reasons for euro optimists not to give up their hopes, with markets pricing in a rise in interest rates in the euro zone at least once during the current year, in addition to the steadfastness of the region’s economy; Few would deny that rising energy prices have cast a shadow over the currency's immediate prospects.
The euro rose by about 13 percent against the dollar last year, but the Iran war harmed the currency's performance this year.
The war disrupted LNG shipments through the Strait of Hormuz, pushing gas prices above 80 euros per megawatt-hour during September, their highest level since late 2022.
Analysts believe that European gas prices need to decline in order for the euro to resume its upward path, but this does not seem likely in the near term.
Caspar Hensse, senior portfolio manager at RBC Blue Bay Asset Management, said: “If we look at the expectations of commodity analysts, most of them expect gas prices in Europe to be within a range between 85 and 100 euros.”
He added: “If that happens, the euro could easily fall to $1.12.”
At the same time, talk about the possibility of the United States imposing a ban on diesel exports may increase pressure on the euro, although analysts do not consider this scenario the basis for their expectations.
ING's currency strategist, Francisco Pizzole, said that the rise in the price of oil to about $115 per barrel will increase pressure on the euro, because reaching these levels would reinforce concerns about economic growth.
He added: “But if central banks maintain their strict stance, the euro should not witness a sharp decline,” noting that ING maintained its forecast of the euro rate against the dollar at $1.16 by the end of the year.
