Euro zone yields fall as Fed signals rates higher for longer

U.S. Treasury yields fell after the announcement while European markets reacted on Thursday, with the German 10-year bond yield, the benchmark for the euro zone, down 2.5 basis points (bps) to 2.56%. "The main flashes from the Fed last night were that...

Euro zone bond yields edged lower on Thursday after the U.S. Federal Reserve signalled it may leave interest rates at an elevated level for longer but shot down talk of raising them again. Fed Chair Jerome Powell told reporters on Wednesday that inflation was too high and progress in bringing it down was uncertain, setting the stage for a potentially extended period with the benchmark policy rate in the 5.25%-5.50% range that has been in place since July.

A big surprise for markets, which helped push U.S. yields lower on Wednesday, was the larger-than-expected reduction in balance sheet runoff under the Fed's quantitative tightening program. U.S. Treasury yields fell after the announcement while European markets reacted on Thursday, with the German 10-year bond yield, the benchmark for the euro zone, down 2.5 basis points (bps) to 2.56%.

"The main flashes from the Fed last night were that... Powell signalled that rate hikes remained unlikely and the Fed announced a slightly-larger-than-expected slowing of QT," said Deutsche Bank strategist, Jim Reid. The spread between U.S. 10-year Treasuries and German Bunds was stable at 205 bps.

Markets are now pricing in only one Fed rate cut this year, in November, after pricing in as many as six earlier this year, according to the CME FedWatch Tool. Powell's words have not disrupted market bets on an ECB rate cut in June, but beyond that the path is unclear.

Government bonds remain highly sensitive to changes in expectations for central bank interest rates. Market pricing currently indicates a roughly 70% chance of a 25-basis-point ECB cut in June, and two or three cuts in total this year. "Whilst the Fed is set to stand firm on rates until it is sufficiently confident inflation is falling sustainably to 2%, the baseline view that policy will eventually be loosened remains largely intact," said Ryan Djajasaputra, economist at Investec.

The German two-year bond yield, which is more sensitive to ECB rate expectations, was down 3 bps at 2.999%. Italy's 10-year yield was down 4 basis points at 3.87%, and the gap between Italian and German 10-year yields widened 2 basis points to 131 bps.

(This story has not been edited by Devdiscourse staff and is auto-generated from a syndicated feed.)