Euro zone bond yields steady after mixed PMI data

Markets were pricing only around 40 basis points of easing from the Fed this year, having trimmed expectations for rate cuts given robust economic growth and inflation that has been stickier than in the euro area. "We think the ECB can be a bit more front-loaded than the Fed in cutting rates but they won't want to diverge too much," said Amanda Sundström, strategist at SEB.

Euro zone government bond yields were steady on Tuesday, as traders digested mixed Purchasing Managers' Index data from the euro area that did not offer any new hints on how fast the European Central Bank could lower borrowing costs. Overall business activity in the euro zone expanded at its fastest pace in nearly a year, HCOB's preliminary composite PMI survey showed, propelled by a recovery in the bloc's dominant services sector.

But manufacturing activity contracted, with the PMI falling to 45.6 from 46.1, holding below the 50 threshold that indicates expansion for the 22nd consecutive month. Germany's 10-year bond yield, the benchmark for the euro zone bloc, was up 1.5 basis points (bps) at 2.51%.

ECB officials are sticking to plans to begin lowering interest rates from their record high in June, although their intentions beyond the June meeting are less certain. "The ECB has been clear with its near-announcement of the first cut in June, with the pace and extent of following cuts continuing to be very much data-dependent," said Philippe Noyard, global head of fixed income at Candriam.

Money markets were pricing around 76 basis points of monetary easing from the ECB this year, or the equivalent of around three quarter-point cuts. On Monday, markets had been pricing around 72 points of easing in 2024.

ECB Vice President Luis de Guindos said the central bank needed to be cautious about moves after June and take into account signals from the U.S. Federal Reserve. Markets were pricing only around 40 basis points of easing from the Fed this year, having trimmed expectations for rate cuts given robust economic growth and inflation that has been stickier than in the euro area.

"We think the ECB can be a bit more front-loaded than the Fed in cutting rates but they won't want to diverge too much," said Amanda Sundström, strategist at SEB. "Our main case is that the Fed will do something but the euro area is looking less strong than the U.S. and inflation is falling faster," Sundström added.

The spread between U.S. 10-year Treasuries and German bunds , a gauge of the monetary policy divergence between the U.S. and the euro zone, was at 208 bps, just off its widest level since 2019 at 220.9 bps reached recently. Sundström said that the spread could widen further in the near term as the ECB was expected to move before the Fed, but in the longer run did not think the divergence would be as large as the Fed embarks on its own easing cycle.

Italy's 10-year yield was lower by 1 bp at 3.81%, and the gap between Italian and German bunds narrowed by 1 bp to 130 bps. Germany's two-year bond yield, which is sensitive to changes in ECB rate expectations, rose 1.5 bps to 2.99%.

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