Following a period of notable weakness at the end of last week, European sovereign bond spreads saw a recovery on Monday. This rebound reflects a cautious but noticeable shift in market sentiment, with investors appearing more confident despite ongoing geopolitical tensions.

Market Stabilization Amid Persistent Geopolitical Risks

Tensions in the Middle East, particularly the unresolved conflict between Israel and Iran, continue to cast a shadow over global markets. However, the absence of further escalation over the weekend appears to have provided some relief to investors. While headlines have not pointed to a resolution, the fact that the situation has not worsened has been enough to calm nerves in the fixed income space, at least temporarily.

Traders reported some signs of short-position unwinding during the morning session, which helped sustain the positive momentum throughout the day. This shift in positioning suggests that market participants had prepared for a potentially more severe deterioration in geopolitical conditions, and the relative calm led to a reversal of those defensive trades.

Performance Across the Curve

Within the eurozone government bond market, the tightening in country spreads was most notable in the intermediate part of the curve:

• Italy-Germany (IK/RX) spreads, a key gauge of investor risk appetite in Europe, tightened by around 2 basis points, settling near 93 basis points after trading as tight as 90bp during the day. This marks a meaningful retracement from last week’s widening.
• 5-year bonds outperformed on the curve. Despite ongoing selling interest in the new 5y benchmark (maturing in October 2030), particularly from systematic accounts, the sector held firm. This suggests that overall demand in this part of the curve remains healthy, supported by macro stability and technical positioning.
• 7-year maturities also showed resilience, although the trading desk noted a lack of meaningful client-driven buying. This might indicate that investors are waiting for more clarity on either geopolitical developments or macroeconomic data before deploying capital in this segment.
• Longer-dated bonds (12-year and beyond) experienced more mixed dynamics. The 12-year sector remained under pressure throughout the day, cheapening relative to both 10- and 15-year maturities. Early strength in the very long end—such as bonds maturing in 2054—faded as the session progressed, with limited follow-through from clients.

Outlook: Gradual Tightening, Cautious Execution

Looking ahead, the trajectory for European sovereign spreads appears tilted toward further tightening, particularly for Italy. Market participants seem cautiously optimistic that stability will prevail, allowing country spreads to compress from their recent wides. However, trading desks remain vigilant, especially given the unpredictable nature of geopolitical risk.

The key takeaway is that while the broader backdrop remains complex, the European fixed income market is showing signs of resilience. Investors are carefully navigating the uncertainty, with a preference for tactical positioning and selective risk-taking across the curve.