Euro Zone Bond Yields Steady Amid U.S. Inflation Anticipation

Euro zone bond yields steadied on Tuesday as investors awaited U.S. inflation data and the European Central Bank's policy decision. Germany's 10-year bond yield was down 1 bp, while Germany's two-year bond yield also dropped. Traders expect the ECB to cut rates by 25 bps on Thursday.

Euro zone bond yields steadied on Tuesday following a series of declines, with investors closely monitoring upcoming U.S. inflation data that could give insight into the Federal Reserve's potential rate-cutting trajectory and the European Central Bank's (ECB) policy decision set for later this week. The German 10-year bond yield, a benchmark for the euro zone, dipped 1 basis point (bp) to 2.157%, having hit a one-month low of 2.147% on Friday.

In parallel, Germany's two-year bond yield, which reacts more sharply to shifts in ECB rate expectations, also slipped 1 bp to 2.206%, marking its lowest level since August 5. It appears almost certain that the ECB will reduce rates by 25 basis points on Thursday, as investors scrutinize what the central bank's subsequent moves might be.

Traders have completely factored in a rate cut for this week and forecast a 50% probability of another 25 bps cut by December, although the likelihood of changes in October is slimmer. Generally, money markets anticipate total rate cuts of 62 bps from the ECB by year-end. According to Paul Hollingsworth, chief Europe economist at BNP Paribas, the core takeaway is: disinflation is progressing, growth is softer than expected, and a return to the 2% inflation target will take time. Consequently, caution is expected from the ECB.

Italy's 10-year yield also decreased by 1 bp to 3.537%, with Italy's new extra-long bond launched on Tuesday generating robust demand, indicating that higher yields on Italian debt remain attractive even as the ECB cuts rates. The U.S. presidential debate between Kamala Harris and Donald Trump, plus looming U.S. inflation data, promise to be significant market drivers. The U.S. and euro zone government bond yields have declined sharply, prompting traders to anticipate aggressive rate cuts from the Fed, which meets next week with a 25 bps cut widely expected, though a 50 bps cut is also under consideration.

(With inputs from agencies.)