Euro area long-dated yields rise after sharp drop, geopolitics in focus

6:08 am Wednesday, October 02nd, 2024

By Stefano Rebaudo

(Reuters) – Euro area government bond yields rose on Wednesday after long-dated yields posted their biggest daily fall since mid-June the day before on concerns about economic growth.

Fears of a wider regional conflict in the Middle East added downside pressure as investors rushed into the safety of government bonds, but its impact remained contained for now. Data showed on Tuesday manufacturing activity across the euro zone declined at its fastest pace this year in September.

Investors await U.S. jobs data due later in the session as the Federal Reserve has shifted its focus to employment indicators after inflationary pressures eased.

Germany’s 10-year bond yield, the benchmark for the euro zone bloc, rose 4.5 basis point (bps) to 2.09%. It hit 2.011% on Tuesday, its lowest level since January, before ending the session with a 9 bps drop.

“Markets are taking a breather after yesterday’s bond rally. However, geopolitics and the central bank’s policy paths remained in focus,” said Massimiliano Maxia, fixed income specialist at Allianz Global Investors.

Euro zone growth could be weaker in the near term than the ECB expects but the recovery should pick up pace later on, ECB Vice President Luis de Guindos said on Wednesday.

Markets priced in a 90% chance of a 25 bps rate cut by the European Central Bank in October, from 80% late on Friday.

The ECB has a “clear-cut” case for cutting interest rates at its next meeting, ECB policymaker Martins Kazaks told Reuters.

Analysts flagged that Kazaks also warned markets against running ahead of themselves” as it is “too early to say we’re done with inflation” and “rates must stay somewhat restrictive.”

Germany’s two-year bond yield, which is more sensitive to ECB rate expectations and already priced in a quick easing path, was up 1.5 bps at 2.04%. It hit 1.987% on Tuesday, its lowest level since December 2022, before ending down 4 bps.

The gap between French and German 10-year yields – a gauge of risk premium that investors demand to hold France’s government bonds – was last at 79 bps, from around 70 bps in mid-September. It reached its widest since 2012 beyond 85 bps during France’s parliamentary elections.

Prime Minister Michel Barnier announced steep public spending cuts and targeted tax hikes for France’s biggest companies and wealthiest individuals on Tuesday to narrow a gaping budget deficit.

“The OAT-led tightening in euro area government bond spreads yesterday was likely partly driven by shorts taking profit ahead of Prime Minister Barnier’s presentation of his government’s policy agenda, but it mostly reversed after the event,” said Andrea Appeddu, rate strategist at Citi.

“Yesterday’s policy announcements add to the downside pressure on French credit ratings,” he added, flagging the increase in 2025 deficit target to 5% from 4.1% earlier and “doubts around the government’s longevity.”

Italy’s 10-year yield rose 5 bps to 3.43% while the gap between Italian and German yields widened to 133.5 bps.

(Reporting by Stefano Rebaudo, editing by Kim Coghill)