Speculation Grows Over Possible Aggressive Fed Rate Cut

Euro zone yields dropped in response to speculation about a potential significant interest rate cut by the Federal Reserve next week. Reports by The Wall Street Journal and Financial Times suggest a close call between a 50 basis points cut or 25 basis points. The ECB also cut rates as expected, impacting bond yields.

Euro zone yields fell on Friday, reflecting a decline in U.S. Treasury yields after media reports fueled speculation about a significant interest rate cut by the Federal Reserve next week. The Wall Street Journal and the Financial Times hinted at a close decision next Wednesday between cutting rates by 50 basis points or 25 basis points, surprising markets that had anticipated a quarter-point move.

The European Central Bank cut rates as expected on Thursday and adjusted its economic forecasts, but provided limited information on future moves. While another cut by December is fully priced in, there's only a 30% chance of an interim move in October. Germany's 10-year bond yield, the euro zone's benchmark, slipped 0.5 basis points to 2.15%, potentially ending the week lower.

More sensitive to ECB expectations, the two-year bond yield fell 2 basis points to 2.21%. Unicredit analysts noted, "We see scope for a further correction in Bunds if data support gradual ECB easing." Ratings agencies Moody's and S&P Global are set to review Spain's sovereign credit rating later Friday. The spread between German and Spanish bond yields widened marginally to 79.1 basis points from 77.8 basis points in the prior session.

Italy's 10-year yield fell 3.5 basis points to 3.52%, and the gap between Italian and German bond yields tightened 2 basis points to 136 basis points. A series of central banks, including the Fed, the Bank of Japan, and the Bank of England, are scheduled to announce rate decisions next week, providing a renewed global monetary policy outlook.

The rate-sensitive U.S. 2-year Treasury yield slipped 5 basis points to 3.60%, as traders bought bonds anticipating an aggressive Fed cut. Citi strategist Dirk Willer said, "A WSJ article seemed to open the door again for 50 basis points, making 25 basis points not quite a done deal yet." However, Citi strategists expect the Fed to cut rates by 25 basis points next week with expected cuts of 50 basis points each in November and December. Traders priced in a 43% chance of a large 50 basis points cut by the Fed next week, up from 28% a day ago, according to CMEGroup's Fedwatch tool.

(With inputs from agencies.)