Eurozone yields set for slight weekly fall as focus turns to US economy

Eurozone government bond yields are set to end the week a few basis points lower after US data supported the view that the Federal Reserve will pause its tightening in June.

Investors have been balancing weak economic data from the US against sticky inflation in the euro area and hawkish remarks from European Central Bank officials reiterating that the ECB has more ground to cover.

An ECB survey on Thursday showed that consumers had raised their inflation expectations in March for the first time since October last year, even as the rate of price growth fell.

In the US, stalled talks over raising the government’s debt ceiling and renewed fears of a regional banking crisis boosted concerns that the US will enter a recession.

US data showed on Thursday the number of Americans filing new claims for jobless benefits jumped last week to the highest level since late 2021, while US producer prices rebounded modestly in April.

Germany’s 10-year bond yield was up 3.5 basis points (bps) at 2.25% and was set to close the week down 4 bps.

Germany’s 2-year yield, most sensitive to expectations about policy rates, was up 4 bps at 2.62%, after falling 0.5 bps so far this week.

After recent remarks from ECB officials, investors chose to focus on French policymaker Francois Villeroy de Galhau, who said on Wednesday the ECB had nearly completed its campaign to raise interest rates and further hikes would be “more marginal.”

“My view is that ECB governing council members are more worried about an economic slowdown in the US and the possible spillover effects on the euro area,” said Andrzej Szczepaniak, senior European economist at Nomura, who forecasts two more 25 bps rate hikes in June and July.

Money market bets on future rate hikes rose slightly during the week. The September 2023 ECB euro short-term rate forward was at 3.61%, implying expectations for an ECB deposit facility rate of 3.7% by autumn.

Italy’s 10-year government bond yield was up 2.5 bps to 4.14% and was set to end the week down 5.5 bps.

The spread between Italian and German 10-year yields – a gauge of investor sentiment towards the Eurozone’s more indebted countries – was at 188 bps, showing a weekly tightening of 3 bps.

Markets were not concerned by Fitch’s review of Italy’s sovereign rating, due later in the session.

Some analysts expect the rating agency to confirm its assessment – BBB with a stable outlook – while flagging risks related to growth weakness in the medium-term and high public indebtedness at a time of increasing interest rates.

But according to Citi, “Italy is at risk of another negative outlook from Fitch,” which could mean 10 bps of knee-jerk widening of the Italian-German yield spread.

Citi analysts argued that such a move would increase the sensitivity of peripheral bonds – those of Italy, Spain, Portugal and Greece – to downside triggers, which may come from an acceleration in quantitative tightening from the ECB, or weakening economic growth.

“While the stable outlook of the BBB-rating appears to be at risk, not least after Fitch’s negative rating action on France a couple of weeks ago, it seems more likely that Fitch skips the Italian review this week,” said Christoph Rieger, head of rates and credit research at Commerzbank.

“More relevant will be Moody’s review next week, where any negative rating action would lead to a junk rating,” he added.

Fitch cut France’s sovereign credit rating by one notch to “AA-,” saying fiscal metrics are weaker than its peers, and it expects government debt/GDP to remain on a modest upward trend. [Reuters]