Are European bond markets overshooting?

The recent rise in Eurozone long-term interest rates could jeopardize the on-going recovery if interest rates went beyond what the fundamentals require. We investigate possible overshooting after identifying the main determinants of long-term interest rates in the Eurozone and in some of its Member States since 1999. We include four categories of fundamentals (macroeconomic, financial, expectations, international). We find that monetary variables, spillovers from US financial markets, expectations and sovereign risks are the main determinants of long-term interest rates in the Eurozone. The empirical model has a very good fit and does not identify recent overshooting. The observed rise since August 2016 is attributed to two factors. The first one is the increase in US long-term interest rates after the reversal in the Fed’s monetary stance. The second factor stems from the political tensions in France, Italy or Spain which generated higher perceived political risk. While the former factor might continue to drive Eurozone interest rates up, the second one might have receded with the results of the French presidential elections and drive interest rates down