Traders increase bets on ECB rate cut to 65%, US tariffs in focus

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Traders increase bets on an ECB rate cut by July 2026

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Euro area borrowing costs hit fresh multi-week lows

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Economists warn of economic fallout from a potential U.S.-China trade war

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French yields remain in focus as Sebastien Lecornu attempts to form a new government

By Stefano Rebaudo

Oct 13 (Reuters) - Euro zone government bond yields hit fresh multi-week lows on Monday, as investors priced in another European Central Bank rate cut and turned their attention to U.S. President Donald Trump's tariff threat against China.

Trump revived the trade war against Beijing on Friday, in reprisal for China curbing its critical mineral exports. Traders slowly increased their bets on future ECB rate cuts in the last few days, including late Friday after Trump said he was weighing a "massive increase" in tariffs on Chinese imports. Traders priced in about a 65% chance of a 25-basis-point ECB rate cut by July, up from around 45% on Friday before Trump's remarks on China tariffs, and 35% in early October. The key rate is seen at 1.85% in February 2027, down from 2% in late September.

Euro area borrowing costs had been in limbo in the last couple of weeks as a U.S. government shutdown and a well-established ECB rate outlook left markets with no clear direction.

Barclays noted on Friday that realised volatility of Bunds reached lows seen during the European Central Bank's quantitative easing. Germany's 10-year Bund yield, the bloc's benchmark, was flat at 2.63% after hitting 2.622%, its lowest since August 5. U.S. Treasury yields fell to multi-week lows on Friday as investors fled risk assets and sought safety in government bonds. The U.S. fixed income market was closed on Monday for Columbus Day. "We should remember just how important the U.S.-China trade truce in May was to dampening fears of a recession after Liberation Day," said Henry Allen, macro strategist at Deutsche Bank, referring to Trump's announcement in April of a range of tariffs on U.S. imports from around the world.

"So any signs of reversal will naturally be met with a risk-off move," he added.

Germany's 2-year yields, more sensitive to expectations for ECB policy rates, fell 1.5 bps to 1.94%.

"The risk from this episode is less the tariffs, and more the unpredictability of policy," said Paul Donovan, chief economist at UBS Global Wealth Management.

"The positive from this episode is that the administration does seem responsive to market moves," he added, arguing there has been a more conciliatory tone from both Trump and U.S. Vice President Vance over the weekend.

The yield gap between safe-haven Bunds and 10-year French government bonds - a market gauge of the risk premium investors demand to hold French debt - was at 83.50 bps. It hit 87.96 bps last week, its highest level since January 13 on concerns about the French fiscal outlook. French Prime Minister Sebastien Lecornu faces a race against time to form a government by Monday's budget deadline. Investors see no clear catalyst for further widening in French spreads absent new elections.

"Sovereign debt spreads have normalized as well, and our data showed no sign of liquidation of French bonds across different maturity segments throughout the week," said Bob Savage, head of markets macro strategy at BNY. (Reporting by Stefano Rebaudo; Editing by Toby Chopra, William Maclean and Frances Kerry)