Euro zone yields rise as ECB and Fed officials sound cautious about rate cuts

BY Reuters | ECONOMIC | 05/17/24 05:55 AM EDT

(Recasts, adds comments, background)

By Stefano Rebaudo

May 17 (Reuters) - Euro zone sovereign bond yields rose on Friday as European Central Bank (ECB) and Federal Reserve officials sounded cautious about monetary easing.

Yields were still on track for a weekly fall as U.S. data showed that inflation and the economy cooled in April, supporting expectations for Fed rate cuts.

ECB board member Isabel Schnabel said the central bank may slash rates in June, adding it should be cautious thereafter.

Germany's 10-year government bond yields, the bloc's benchmark, rose 4.5 basis points (bps) to 2.49% and were set to end the week down 3 bps.

"While Schnabel is a known hawk, we suspect this line of thinking will quite easily get support at the meeting in June and potentially quickly become the agreed communication," said Derek Halpenny, head of research global markets at MUFG Bank.

Market participants label as hawks central bank officials who advocate a tight monetary policy to control inflation, while doves focus more on economic growth and the labour market.

"The comments this week from Fed officials were, in our view, still indicative of a Fed that would be willing to turn and cut relatively quickly if the evidence becomes available to back it up," Halpenny added.

Fed officials acknowledged the positive turn after this week's economic figures, but didn't say anything concrete about when rates might fall.

"Quite a lot more additional data will be required before the FOMC is likely to feel comfortable to start cutting rates," said Mark Dowding, BlueBay CIO, RBC BlueBay Asset Management.

Market participants, who forecast a softening of the U.S. economy, said retail sales numbers released on Wednesday aligned with U.S. consumer sentiment, weekly jobless claims and figures from the Institute for Supply Management (ISM) released in the last couple of weeks.

Markets price in 68 bps of ECB rate cuts in 2024 from 72 the day before, and 46 bps for the Fed from 50 bps.

They also discount almost no chances of an ECB move in July and an around 80% chance of a second rate cut by September..

Policymaker Martins Kazaks, seen as a hawk, said on Thursday that the ECB is not in a hurry to ease monetary policy after June, adding that he was relatively fine with the current market pricing and that disturbing it would mean more volatility.

ECB Vice-President Luis de Guindos, seen as a dove, said there was increased confidence among policymakers that inflation will ease back to target next year.

Analysts said euro zone manufacturing Purchasing Managers' Index (PMI) data, due next week, will guide sentiment about U.S. and euro zone growth, possibly affecting the yield spread between U.S. Treasuries and German Bunds.

Bund yields have recently tracked Treasury dynamics, leaving the 10-year spread at around 190 bps.

The gap between U.S. and German yields - a gauge of the expected policy path divergence between the ECB and the Fed - was last down 2 bps at 189 bps.

Italy's 10-year yield fell 4.5 bps to 3.79%, and the yield gap between Italian and German bonds - a gauge of the risk premium investors seek to hold bonds of the euro area's most indebted countries - was at 131 bps. (Reporting by Stefano Rebaudo, editing by Neil Fullick and Nick Macfie)

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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