Euro Area Long-Dated Yields Increase Following Significant Drop, Geopolitics Under Scrutiny – Reuters

By Stefano Rebaudo

Euro area government bond yields increased on Wednesday following a significant decline in long-term yields the previous day, driven by concerns regarding economic growth.

Tensions surrounding a potential broader conflict in the Middle East contributed to market stress, prompting investors to seek refuge in government bonds, although the overall impact remained manageable for the time being. Recent data indicated that manufacturing activity across the euro zone fell at its fastest rate this year in September.

Market participants are anticipating U.S. jobs data set to be released later in the day. The Federal Reserve has shifted its focus to employment metrics now that inflationary pressures have diminished.

Germany’s bond yield, which serves as a benchmark for the euro zone, rose by 4.5 basis points to 2.09%. It had reached a low of 2.011% on Tuesday, the lowest point since January, before closing the previous session with a 9 basis point drop.

“Markets are taking a breather after yesterday’s bond rally. However, geopolitical issues and the central bank’s policy direction remain key points of interest,” noted Massimiliano Maxia, a fixed income specialist at Allianz Global Investors.

ECB Vice President Luis de Guindos remarked on Wednesday that short-term growth in the euro zone may be weaker than anticipated, although a recovery is projected to gain momentum later on.

Markets are now pricing in a 90% likelihood of a 25 basis point rate cut by the European Central Bank in October, an increase from 80% just days earlier.

According to ECB policymaker Martins Kazaks, there is a “clear-cut” case for cutting interest rates at the next meeting. However, he cautioned against taking premature action, stating that “it is too early to say we’re done with inflation” and emphasized the need for rates to remain somewhat restrictive.

Germany’s two-year bond yield, which is particularly sensitive to ECB interest rate expectations, rose by 1.5 basis points to 2.04%. It had touched 1.987% on Tuesday, marking its lowest level since December 2022, before ending down 4 basis points.

The difference between French and German 10-year yields, reflecting the risk premium for holding French government bonds, was last recorded at 79 basis points, up from around 70 basis points in mid-September. This spread had previously widened beyond 85 basis points during France’s parliamentary elections in 2012.

Prime Minister Michel Barnier announced significant public spending cuts and targeted tax increases for major corporations and wealthy individuals on Tuesday as part of an effort to address a substantial budget deficit.

“The tightening in euro area government bond spreads led by French bonds was likely influenced by profit-taking ahead of Prime Minister Barnier’s policy agenda presentation, but the trend mostly reversed after the announcements,” stated Andrea Appeddu, a rate strategist at Citi.

Appeddu added that the recent policy announcements further exert downward pressure on French credit ratings, pointing out the increase in the 2025 deficit target from 4.1% to 5% and raising “doubts about the government’s stability.”

Italy’s 10-year yield rose by 5 basis points to 3.43%, while the spread between Italian and German yields widened to 133.5 basis points.