Yields hold steady as markets await US data and ECB meeting

German government bond yields held steady on Monday as investors turned their focus to key US data and a policy meeting of the European Central Bank (ECB) due later this week.

Eurozone borrowing costs lost ground recently as economic figures showed a bleak outlook and market inflation expectations dropped to below 2%.

Germany’s 10-year yield, the benchmark for the eurozone, was last at 2.12%, little changed on the day.

It has recently been trending lower but last week saw its first weekly rise in more than a month, with an increase of 6 basis points (bps).

ECB policy will be crucial for its future direction. Most analysts expect a 25bps ECB rate cut on Thursday and will focus on the communication, which could provide clues about the ECB’s future moves.

“They (the ECB) could remove the reference to the Governing Council keeping policy rates ‘sufficiently restrictive’, thus suggesting that the path towards neutral rates has now been cleared,” said Reinhard Cluse, chief European economist at UBS.

The neutral rate — which many analysts see at about 2% — is the theoretical interest rate that would keep the economy operating at full employment and stable inflation.

“In the press conference, president (Christine) Lagarde might also say that the ECB is broadly on track to returning inflation back to the target,” he added.

Money markets priced in a depo rate of 1.87% in July, down from the current 3.25%, while fully discounting a 25bps rate cut in December and almost no chance of a 50bps move.

Also important for bonds will be US inflation data on Wednesday, which may affect expectations for the Federal Reserve’s monetary easing path.

Investors are now pricing in an 87% chance of a 25bps Fed cut, in line with the levels seen on Friday after US figures, according to the CME’s FedWatch Tool.

The gap between French and German yields — a gauge of the risk premium investors demand to hold French debt — narrowed by 2bps to 75bps while investors closely watched political developments in France after the fall of Prime Minister Michel Barnier’s government.

It has been widening this year on political uncertainty in France, the eurozone’s second-largest economy. But it hit 72.40bps on Friday, its lowest since November 21, as hopes grew that France may end up with a 2025 budget approved by parliament, while the prospect of EU joint funding fuelled broader convergence among bond yields.

“Doubts on the sustainability of the euro construct could resurface,” said Raphael Gallardo, chief economist at Carmignac, referring to the political crisis in France.

“France cannot deflate its debt or devalue its currency. The pain of the fiscal adjustment will be felt in the real economy, notably on the labour market,” he added.

Italy’s 10-year government bond yields — the benchmark for the euro area periphery — dropped 1bps to 3.19%. The BTP yield spread was 2bps narrower at 107bps, after briefly hitting a fresh 37-month low early this morning at 104.5bps.

Reuters