Euro area yields edge up after 3-day slide, bets on ECB cuts unchanged

By Stefano Rebaudo

Aug 6 (Reuters) - Euro zone government bond yields were set to break a three-day losing streak on Wednesday, taking cues from U.S. Treasuries, while traders continued to price in a 90% chance of a European Central Bank rate cut by March 2026.

U.S. yields fell sharply on Friday after weaker-than-expected jobs data triggered a strong dovish repricing of Federal Reserve monetary cycle. They edged higher on Tuesday, even as economic data pointed to stalling activity in the services sector.

Germany's 10-year bond yield, the benchmark for the euro zone, rose 2.5 basis points (bps) to 2.65%.

Benchmark 10-year U.S. yield was up 4 bps at 4.24% in London trade.

The yield gap between U.S. and German 10-year government bonds was at 159 bops after hitting 153.3 last week, its lowest level since early April.

"A stalling U.S. economy should lead to further Treasury outperformance and a smaller growth differential between the US and the euro area," said Reinout De Bock, rate strategist at UBS, adding that he has a 135 basis point target.

"What could also help the trade, is that the bar for a September cut by the ECB seems high."

Money markets priced in an around 60% chance of a rate cut by year-end and an 80% chance of the same move by March 2026.

Traders are pricing in a 90% probability of a 25-bp rate cut by the Fed in September, and a total of 125 bps of easing by October 2026.

"Given the inflation backdrop the Fed is in a tough spot. More evidence of labour market weakness is required for a move, but I guess that is what markets will possibly bet on now," said Chris Iggo, CIO at AXA Core Investments.

"I sense expectations have changed on the U.S. economy's near-term outlook. Recession risks have increased."

Germany's two-year yield rose 1.5 bps at 1.91%.

Italy's 10-year yield rose 3 bps to 3.48%, with the spread versus Bunds to 82.5 bps. It hit 81.44 on Tuesday, its lowest since April 2010.

Analysts argued that with the ECB easing cycle close to an end, the air for a further BTP-Bund spread compression will probably become thinner after the summer.

They recalled that some technical factors could also fade. Positive ratings kicked off the tightening, but declining volatility favouring carry trades and lower supply over the summer have helped to extend the rally.

(Reporting by Stefano Rebaudo, Editing by Bernadette Baum)