Euro zone yields edge down, markets price in 25% chance of 2026 ECB rate cut

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Bund yields hold at levels last seen at start of US shutdown

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US data in focus, but it will take time to assess economy

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Markets consolidate higher-for-longer view on ECB rates

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Euro area spread tightening may be over, says FTI strategist

By Stefano Rebaudo

Nov 17 (Reuters) - Euro area benchmark Bund yields dropped on Monday, partially reversing gains from the previous session, as markets acknowledged it would take time to accurately gauge the economy while U.S. agencies clear a backlog of data.

Market participants expect September's U.S. payroll data to be released later this week.

Germany's 10-year yield fell 0.5 basis points (bps) to 2.71%, after touching its joint-highest since October 7 at 2.718%. The euro zone economy will grow faster than earlier expected in 2025, the European Commission forecast on Monday, mainly thanks to a surge in exports in the first half of the year ahead of expected tariff increases. However, Bund yields kept hovering around the levels they were when the U.S. shutdown began. The Bund yield closed at 2.7134% on October 1.

KEY RELEASES FOR FED POLICY MAY COME IN DECEMBER

Analysts expect more U.S. economic figures to start coming in this week, with volatility likely to pick up. However, the key releases for shaping the Federal Reserve's policy path, such as the consumer price index, are scheduled for December, they say.

With European Central Bank policy on hold, the focus is elsewhere, mainly on expectations for U.S. Federal Reserve policy. Money markets have in recent days priced the chance of a 25-bp rate cut next month at around 50%, according to CME Group FedWatch Tool. Chances on Monday were 44% from 60% a week ago. A drumbeat of hawkish remarks from FOMC members, including the presidents of the Dallas, Cleveland, and Boston Fed banks, has made investors more cautious about a potential Fed easing move in December.

MARKETS PRICE IN A 25% CHANCE OF A ECB RATE CUT IN 2026 Remarks from European Central Bank Governing Council members Gabriel Makhlouf and Olaf Sleijpen supported expectations that the central bank will remain firmly on hold.

In the euro area, markets priced in a 25% chance of a 25-bp ECB rate cut by July next year from 45% early last week. They also indicated an ECB deposit facility rate at 1.95% in December 2026 from the current 2%. Germany's two-year yield, which is sensitive to changes in ECB rate expectations, fell 0.5 bps to 2.03%, after reaching 2.044%, a new 7-1/2-week high. Italy's 10-year government bond yield fell 2 bps to 3.45%, after hitting 3.474%, a fresh five-week high. The gap over safe-haven German Bunds - a key gauge of the extra return investors demand to hold Italian debt instead of safe-haven German bonds - was at 73.50 bps, after last week hitting a new 15-year low at 70.68 bps.

"The theme of the year has been European spreads versus Germany's Bunds," said Michael Browne, global investment strategist at Franklin Templeton Institute. He noted that yield gaps hit fresh lows after media reports questioned whether Chancellor Friedrich Merz's government will follow through on its 500 billion-euro fiscal boost, amid uncertainties that have weighed on polling for Germany's nine-month-old administration.

"Watch this space, but I think spread-betting may be over," Browne added. German Finance Minister Lars Klingbeil is visiting China, with Berlin under pressure as a record trade gap widens and supply chains wobble. Merz said on Monday that Germany could be facing the greatest challenges since World War Two, citing its diplomatic relationships with China and the United States.

The yield gap between 10-year French government bonds and Bunds was at 74 bps after hitting 70.50 bps last week, its lowest since August. The spread hit 87.96 bps in early October, the widest since January, driven by investor concerns over France's fiscal trajectory. (Reporting by Stefano Rebaudo, additional reporting by Samuel Indyk; Editing by David Goodman, Conor Humphries and Ed Osmond)