Friday, May 27

Euro zone bond yields fall, but show muted reaction after Fed rally

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Shorter-dated euro zone and Southern European bond yields fell on Thursday, but showed a more muted reaction than other markets to Federal Reserve Chair Jerome Powell ruling out bigger rate hikes, as focus remained on a hawkish European Central Bank.

The Federal Reserve on Wednesday raised its benchmark interest rate by half a percentage point, the biggest rise in 22 years, but Powell explicitly ruled out raising rates by 75 basis points (bps) in a coming meeting, triggering a sharp rally in US Treasuries and stocks.

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By 1025 GMT on Thursday, Germany’s 10-year yield, the benchmark for the bloc, was down a basis point to 0.98% after briefly rising back above 1% in earlier trade. Two-year yields, sensitive to interest rate expectations, were down 4 bps 0.23%.

While the euro zone market followed overnight moves in US Treasuries, yield falls were much sharper in the United States, where the two-year Treasury yield fell 13 bps on Wednesday.

Euro zone money markets also pared back bets on ECB rate hikes this year, but only very slightly, with around 88 bps of hikes priced in by the end of the year, compared to over 90 on Wednesday, according to Refinitiv data.

“I think euro rates still have a hawkish ECB to consider, there’s not a change on that front,” said Peter McCallum, rates strategist at Mizuho in London.

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“That front end repricing from the Fed does mainly help risk assets, that’s the main takeaway in Europe,” he added.

In Italy, the 10-year yield was down 3 bps to 2.94% , tightening the closely watched risk premium over German bonds to 195 bps, after hitting the highest since May 2020 at over 198 bps on Wednesday.

Credit markets also rallied, with the spread on the iTraxx Europe crossover index, which measures the cost of insuring exposure to high yield bonds, falling over 10 bps.

Monetary policy remains firmly in focus, with the Bank of England set to raise interest rates for the fourth time since December. Investors will also follow speeches from ECB policymakers including chief economist Philip Lane.

Earlier on Thursday, ECB board member Fabio Panetta said the bank should not raise interest rates in July, a move an increasing number of policymakers are advocating, and should wait to see euro zone second quarter GDP data.

In the primary market, Spain raised 5.61 billion euros from five to 50-year bonds and France raised 10.99 billion euros from 10 to 30-year bonds. (Reporting by Yoruk Bahceli Editing by Kim Coghill and Mark Potter)

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