Euro zone bond yields fall as markets firm up rate cut bets

BY Reuters | ECONOMIC | 12/01/23 11:34 AM EST

By Harry Robertson and Samuel Indyk

LONDON, Dec 1 (Reuters) - Euro zone bond prices rose on Friday, a day after clocking their best month in more than a year, as soft U.S. data and comments from Federal Reserve Chair Jerome Powell supported the view that rate cuts could come as early as the first quarter next year.

Powell said the risks of under- and over-tightening have become more balanced, although he reiterated that it was still too early to declare the Fed's inflation fight finished. He also said it would be premature to speculate on when policy might ease.

Meanwhile, U.S. manufacturing activity remained subdued in November, according to the Institute for Supply Management. Its purchasing managers' index was unchanged at 46.7, below expectations for a rise to 47.6 and below the 50 threshold that separates expansion from contraction.

Germany's 10-year bond yield was down 8 basis points (bps) at 2.369%, after rising 6 bps on Thursday. The yield, which moves inversely to the price, fell by 36 bps in November in its biggest monthly drop since July 2022, reflecting a dramatic rally in prices.

Italy's 10-year yield was down 11.5 bps at 4.113%, after dropping by 49 bps in November.

"It's just a continuation of the very, very strong trend of this week," said Piet Haines Christiansen, fixed income strategist at Danske Bank. "What has been dominating this past week is kind of a fear of missing out."

Powell's Fed colleague Christopher Waller gave November's bond rally new legs earlier this week when he suggested that interest rates could fall in the coming months as inflation cools.

Markets are now pricing in well over 100 bps each of rate cuts from the Fed and European Central Bank next year but many central bankers, particularly in the euro zone, are pushing back against those bets.

Business survey data on Friday showed that the downturn in euro zone manufacturing continued in November, albeit at a slightly slower pace. Italy's factory sector fared worse than expected, however, contracting at the fastest rate since June.

Traders on Thursday moved to fully price in 25 bps of rate cuts from the ECB by April, after a slowdown in inflation and growth data across the bloc. By Friday, traders saw a roughly 75% chance of the first cut coming by March, according to money market pricing.

Germany's 2-year bond yield, which is sensitive to ECB rate expectations, was last down 14.5 bps at 2.671%, at its lowest since May.

Euro zone bond investors will pay close attention to ratings agency Fitch's assessment of Greece on Friday, due after the market closes.

Strategists at UniCredit said they think Fitch is likely to upgrade Greece's sovereign credit rating back to investment grade, following S&P's upgrade in October.

"This would allow Greek government bonds to be included in most investment-grade bond indices and thus attract steady demand from a bigger pool of global investors," they said on Friday.

Greece's 10-year bond yield was down 3.5 bps at 3.61% on Friday. The spread of Greek yields over the German benchmark was at 113 bps, not far off the five-month low of 108 bps touched in late November.

The gap between Italy and Germany's 10-year bond yields narrowed to 172 bps. The yield spread, a gauge of investor confidence in the euro zone's more-indebted countries, fell to a two-month low of 170 bps in November.

(Reporting by Harry Robertson, Additional reporting by Samuel Indyk; Editing by Kim Coghill, Sharon Singleton and Andrea Ricci)

In general the bond market is volatile, and fixed income securities carry interest rate risk. (As interest rates rise, bond prices usually fall, and vice versa. This effect is usually more pronounced for longer-term securities.) Fixed income securities also carry inflation risk and credit and default risks for both issuers and counterparties. Unlike individual bonds, most bond funds do not have a maturity date, so avoiding losses caused by price volatility by holding them until maturity is not possible.

Lower-quality debt securities generally offer higher yields, but also involve greater risk of default or price changes due to potential changes in the credit quality of the issuer. Any fixed income security sold or redeemed prior to maturity may be subject to loss.

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