Euro Zone Bond Yields Drop Amid U.S. Election Developments

Euro zone government bond yields fell on Tuesday as investors focused on the U.S. presidential campaign. U.S. President Joe Biden endorsed Vice President Kamala Harris, creating uncertainty about her impact on the upcoming election against Donald Trump. European Central Bank signals also influenced bond yield movements.

Euro zone government bond yields decreased on Tuesday following an increase the previous day, as investors monitored the developments in the U.S. presidential campaign and stable expectations for the European Central Bank's (ECB) monetary easing path. U.S. President Joe Biden's decision to exit the race and endorse Vice President Kamala Harris as the party's candidate against Republican Donald Trump added to uncertainty.

Analysts noted that it would take weeks to understand Harris' potential impact on Trump's chances in the November 5 election. Meanwhile, U.S. Treasury yields rose slightly on Monday as markets weighed the uncertainties surrounding the White House race.

Germany's 10-year government bond yield, the euro area's benchmark, fell 3 basis points (bps) to 2.45% after a 2 bps increase the day before. ECB Vice-President Luis de Guindos indicated a possible interest rate cut in September, citing the ECB's new projections as a key factor in determining inflation trends.

Money markets currently predict an 80% chance of a rate cut in September and an equal probability of two additional cuts by year-end. ING analysts believe that as the Federal Reserve and ECB implement rate cuts, yields could decline, albeit with a limited scope due to a well-anchored ECB terminal rate of 2.25%.

The yield difference between Italian and German 10-year bonds, a measure of the risk investors require to hold Italian debt, was at 128 bps, after reaching 120 bps following French President Emmanuel Macron's call for snap elections. Macron's decision had ignited fears about increased fiscal spending under a potential far-right government, threatening France's public debt sustainability.

Concerns eased after the vote results left Macron's Together group in charge of forming a new government without far-right and far-left party involvement. "With positive momentum and lighter supply ahead, we estimate net issuance to be near zero until year-end. Italian bond spreads have potential for further performance against Bunds and OATs," said Commerzbank's rate strategist Hauke Siemssen.

The yield spread between Italian and French bonds dropped to 55 bps last week, its lowest since October 2021. Peripheral euro zone countries like Italy, Spain, Portugal, and Greece, have experienced tightened yield spreads amid concerns over France's public debt trajectory.

(With inputs from agencies.)