Euro zone government bond yields fell Monday in limited trading due to a public holiday in London, after Friday’s U.S. economic data moved the needle on market bets toward higher probability of two rate cuts from the Federal Reserve in 2024.
At the same time, the spread between Italian and German 10-year bond yields hit its lowest level in a month and a half after Fitch affirmed its rating of Italian debt.
The yield on German 10-year bonds, the benchmark for the euro zone, fell 6 basis points (bps) to 2.45%.
US Treasury yields were down 2.5 basis points in London, after falling to multi-week lows on Friday, following news that the world’s largest economy created fewer jobs than expected in April .
“We see the risk that an overly innovative Fed will lead to some steepening of the yield curve from here. The back end will not feel sufficiently protected, while the front end could start to settle into a reduction in September,” said Padhraic Garvey, regional head of research for the Americas at ING, mentioning a likely contagion effect on Bunds.
The German yield curve was still inverted but steepened on Friday, with the spread between German 10-year and 2-year yields narrowing to 43 basis points after four consecutive sessions of widening. It was 44 basis points on Monday.
Money markets price ECB rate cuts in 2024 at 75 basis points and Fed rate cuts at 48 basis points, implying a 25 basis point cut and a 90% probability of further movement .
The Italian 10-year yield fell 7 basis points to 3.75%, and the spread between the Italian and German 10-year yields – a measure of the risk premium investors demand for holding the countries’ bonds the most indebted in the euro zone – was at 128 basis points after reaching 122.60 basis points, its lowest level since March 20.
“European government bond spreads have room to tighten amid confidence and favorable flows in May,” said Rainer Guntermann, economist at Commerzbank.
“Rating risks remain contained, with Fitch having just confirmed Italy’s rating and the market not being concerned about Moody’s review at the end of May after raising the outlook to stable in November 2023” , he added. Investors will closely monitor the BTP-Valore sale, which begins on Monday, as small Italian savers will likely rush to buy the new retail bond, taking advantage of the last opportunity to lock in higher yields before the ECB begins to reduce interest rates.
The case for an ECB interest rate cut in June is growing stronger as services inflation finally begins to ease, said Philip Lane, the ECB’s chief economist. (Reporting by Stefano Rebaudo, Editing by Emelia Sithole-Matarise)
