Euro zone bond yields drop as US data support Fed rate cut bets

By Alun John

LONDON, Nov 25 (Reuters) - Euro zone bond yields nudged lower on Tuesday as U.S. Treasury yields declined on the back of growing expectations the Federal Reserve will deliver a December rate cut.

Germany's 10-year Bund yield was down 2.5 basis points (bps) at 2.67%, broadly in the middle of its range for much of this year.

U.S. Treasury yields kept declining on Tuesday, with the benchmark 10-year down 5.5 bps at 4.49%, amid a flurry of economic data releases that did little to dissuade investors about the likelihood of an interest rate cut by the Federal Reserve next month.

With markets seeing the European Central Bank as firmly on hold, European rates have been fairly muted in recent weeks. Spillovers from moves in stocks or U.S. and Japanese government bonds have not been sufficient to drive significant shifts either.

The decline in U.S. yields helped the gap between German and U.S. 10-year yields drop to 132.8 bps on Monday, its narrowest closing level in two months. It ticked slightly wider again on Tuesday.

Analysts at UBS said the fact investors cannot be too confident about the direction of central bank policy on either side of the Atlantic is adding a note of caution to markets.

"Divergence in central bank views and delayed data make high-conviction trades harder," they wrote in a note to clients.

They observed that while ECB President Christine Lagarde has repeatedly said its policy rate is "in a good place", she warned last week about the euro zone's growth vulnerabilities.

Meanwhile, in the U.S., though the last few Fed speakers have indicated they are open to a rate cut in December's meeting, others last week were less sure.

"You might see the least groupthink you've seen from the FOMC (rate setting committee) in a long time," Fed Governor Christopher Waller said last week.

The slow trickling in of U.S. economic data delayed by the government shutdown further adds to the uncertainty.

U.S. retail sales and PPI for September are due later Tuesday.

The back-and-forth around a possible peace deal to end the war in Ukraine has also had little effect on euro zone bonds even as it moves stocks, particularly defence names.

Analysts at ING said that if a Ukraine deal were to lead to lower gas prices, and so lower inflation, that could cause euro zone yields to fall.

Elsewhere in Europe on Tuesday, French and Italian 10-year yields were largely moving in line with Germany's.

France's 10-year yield was down 4.5 bps at 3.40% and Italy's was down a similar amount at 3.40%.

(Reporting by Alun John; Editing by Emelia Sithole-Matarise, Krishna Chandra Eluri and Mark Heinrich)