Eurozone Bond Yields Fall Amid Economic and Political Uncertainty

Eurozone government bond yields dropped for the second consecutive day as investors awaited the European Central Bank's policy announcement. German investor morale worsened, with concerns over exports, political uncertainty, and the ECB's policy outlook. Interest rates are expected to remain steady, with potential rate cuts dependent on economic data.

Eurozone government bond yields fell for the second day on Tuesday as investors anticipated Thursday's European Central Bank policy announcement, with data suggesting a further slowdown in Germany, Europe's top economy. Germany's 10-year bond yield, a key benchmark, dropped by 3.5 basis points to 2.437%, following a 2.5 bps fall on Monday.

German investor morale took a steeper dive than expected in July, the ZEW economic research institute reported, emphasizing fears regarding Germany's economic recovery. The downturn in morale was linked to declining exports, political instability, and ambiguous ECB policy, the ZEW noted.

The European Central Bank, set to announce its policy on Thursday, is predicted to maintain interest rates. Future rate cuts will hinge on economic developments. "They will likely state a data-dependent approach, implying potential cuts in September, but will refrain from committing without supporting data," stated Anders Svendsen, Nordea's chief analyst.

According to LSEG data, the futures market sees less than a 10% chance of a move in Thursday's meeting but around an 85% likelihood of a quarter-point cut in September. Germany's two-year yield also dipped 4 bps to 2.752%, its lowest since June 21.

POLITICAL UNCERTAINTY CONTINUES Investors were also evaluating the impact of the assassination attempt on U.S. presidential candidate Donald Trump on financial markets.

Markets speculated that Trump's improving election chances might drive U.S. inflation and elevate the deficit. The U.S. 10-year yield, which rose on Monday, fell by 5 bps on Tuesday, erasing the previous gain and settling at 4.183%.

"There appears to be no lasting market impact from the assassination attempt," said Sophia Oertmann of DZ Bank. "Markets had already factored in Trump's raised chances post-TV debate."

In France, President Emmanuel Macron is expected to accept his government's resignation to allow lawmakers to begin their parliamentary session on Thursday. France's 10-year yield dipped 3 bps to 3.084%, a low since the June 7 trading day before Macron initiated the snap election.

The yield gap between French and German 10-year bonds was 65 bps, 15 bps wider than before June 9. This spread, a crucial risk gauge, peaked at 85 bps in late June, the highest since the eurozone crisis in 2012.

"I don't foresee significant changes to the current 65 bps spread due to persistent uncertainty," noted DZ Bank's Oertmann. "Even with potential new government cooperation, implementing key reforms will remain challenging," she added.

(With inputs from agencies.)