Euro Zone Bonds Respond to Mixed Economic Signals

Euro zone bond yields showed mixed reactions on Thursday, influenced by unexpected U.S. growth data and declining German inflation. The German 10-year bond yield rose slightly, while the market cautiously welcomed another U.S. data set indicating strong consumer spending. Analysts remain divided on the European Central Bank's next steps.

Euro zone bond yields demonstrated varied movements on Thursday, reacting to stronger-than-anticipated U.S. growth figures that buoyed Treasury yields, counteracting the impact of diminished German inflation data on the bloc's bond markets. The German 10-year bond yield nudged up 2.6 basis points to 2.28% by early evening in London, having dropped to as low as 2.22% earlier in the day.

U.S. bond yields ascended across the board following data showing the U.S. economy expanded more quickly than initially thought in the second quarter, driven by robust consumer spending. The Gross Domestic Product rose at a 3.0% annualized rate last quarter, surpassing forecasts of 2.8% growth. Additionally, fewer Americans filed new jobless benefit claims last week, further bolstering positive sentiment.

Commenting on the data, David Russell, Global Head of Market Strategy at TradeStation, said, 'The claims data, GDP revision, and trade deficit tell a singular story: Demand is strong for both goods and labor. While it's encouraging to see less evidence of a recession, today's numbers potentially counter the notion of continuous rate cuts by the Fed.'

Following the data release, stock markets in Europe and the U.S. traded near all-time highs, despite lackluster earnings from AI industry leader Nvidia. In the German market, the two-year yield dipped 1.4 basis points to 2.365%, after hitting a low of 2.326% earlier.

The decrease was prompted by data indicating a sharper-than-expected fall in German inflation in August, which eased to its lowest in over three years due to reduced energy prices. German inflation dropped to 2.0% in August, below the 2.3% forecasted by economists polled by Reuters.

Adding to expectations of a broader decline, separate data revealed Spanish inflation fell to 2.4% year-on-year in August, down from 2.9% in July based on harmonized European Union standards. The euro zone inflation data scheduled for release on Friday is keenly anticipated.

Market expectations for the European Central Bank (ECB) rate cuts increased modestly, now predicting around 64 basis points of cuts by year-end, potentially implying a 25 basis point cut at the September meeting, with additional cuts in October or December. However, some analysts, including Althea Spinozzi, Head of Fixed Income Strategy at Saxo Bank, caution against overstated reactions.

'Despite positive inflation figures in Germany, core inflation remained elevated in the second quarter of the year, likely preventing the ECB from delivering three rate cuts this year,' said Spinozzi. Italian bond yields also responded to the German data, with Italy's 10-year yield dropping 2.1 basis points to 3.67%, narrowing the spread between Italian and German bond yields to 137 basis points.

Adding to the developments, Italy's funding costs edged down at an auction on Thursday where it sold the targeted amount of 9.25 billion euros ($10.25 billion) across three bonds.

(With inputs from agencies.)