Euro zone yields fall, markets price in 50 bps of ECB rate cuts by July

Euro area sovereign bond yields were set for their biggest weekly fall since end-May, with data on Friday showing U.S. employers added fewer jobs than expected last month after central banks on both sides of the Atlantic left rates unchanged.
 

The U.S. figures showed employers added 150,000 jobs in October, below the 180,000 expected by economists.
 

Meanwhile, the euro zone's recent economic data has pointed to a weak economy with easing inflation, with money markets fully pricing 50 basis points of European Central Bank rate cuts by July next year.
 

The ECB last week hinted at a steady policy ahead, while pushing back on expectations for rate cuts any time soon.
 

The Bank of England held borrowing costs at a 15-year peak on Thursday, stressing the need to continue fighting inflation, while the previous day the U.S. Federal Reserve supported market expectations that it is at the end of its tightening path.
 

Germany's 10-year government bond yield, the benchmark for the euro area, was up one basis point (bp) at 2.72% and set to end the week down 11.5 bps.
 

Money markets priced in 50 bps of rate cuts by the ECB by July 2024.
 

July 2024 ECB euro short-term rate (ESTR) forwards were at 3.38%, implying market expectations for a deposit facility rate at 3.48% from the current 4%. July Forwards at 3.4% imply expectations for 50 bps of rate cuts.
 

ECB ESTR forwards are pricing 95 bps of rate cuts in 2024 from around 45 bps in mid-October. They fully price in the first ECB easing move by June.

The ECB is on track to push inflation back down to 2% by 2025 but the "last mile" of disinflation may be the toughest, so the bank cannot yet close the door on further rate hikes, ECB board member Isabel Schnabel said on Thursday.
 

U.S. Treasuries have led the way recently, with benchmark 10-year yields tumbling to three-week lows on Thursday amid relief that the U.S. government had announced smaller-than-expected increases in longer-dated supply and after Fed remarks about its future policy.
 

"By essentially referencing the higher longer rates as reason to withhold further tightening, it (the Fed) has created an awkward interdependency with the market," said Padhraic Garvey, regional head of research Americas at ING.
 

ITALY OUTPERFORMS
 

Italy's 10-year government bond yield, the benchmark for the euro area's periphery, dropped 9 bps to 4.48% and was on track to end the week down 25 bps, its biggest fall since end-May.
 

Such a move drove the gap between Italian and German 10-year yields – a gauge of the risk premium investors ask to hold debt of the euro zone's most indebted countries – to its tightest level since end-September at 180.3 bps.
 

Strong bond demand led by investors keen on locking in the highest yields in over a decade, along with the ECB's focus on avoiding an excessive widening of spreads, are expected to keep yield gaps between core and peripheral bonds in check.
 

The ECB confirmed last Thursday that it would continue reinvestments from the Pandemic Emergency Purchase Programme (PEPP) until the end of 2024. Still, ECB President Christine Lagarde said the council had yet to discuss the issue.
 

The ECB can use reinvestments from the PEPP to support bonds of southern Europe's most indebted countries. Lagarde called it the first line of defence against fragmentation – an excess widening of yield spreads among the euro area's bonds, which might hamper monetary policy transmission.
 

(Reporting by Stefano Rebaudo; Editing by Gareth Jones and Alexander Smith)

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