EU bond yields fall as market focus shifts to Fed and U.S. tariffs
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Eurozone government bond yields fell to their lowest levels in two weeks on Wednesday, as investors recalibrated their expectations ahead of the Federal Reserve's policy decision and potential disruptions from U.S. tariff escalation. The German Parliament’s recent approval of a historic increase in public spending has further shaped market sentiment, raising long-term debt concerns despite short-term growth optimism.
Market Reaction: Declining Yields Across the Eurozone Germany’s 10-year Bund yield dropped 4.5 basis points (bps) to 2.87%, reaching a session low of 2.748%, its lowest since March 5. This movement follows last week's peak of 2.938%, the highest since October 2023. The 2-year Bund yield, which is more sensitive to European Central Bank (ECB) rate expectations, also edged lower by 2 bps to 2.16%, reflecting ongoing speculation about potential monetary easing.
Meanwhile, Italy’s 10-year yield fell 3.5 bps to 3.83%, its lowest level since early March, after reaching a multi-month high of 3.997% last week. The spread between Italian and German 10-year bonds remained at 106 bps, a key gauge of investor risk perception regarding Italian debt. Similarly, the spread between French and German bonds stabilized at 67 bps, at the lower end of its recent range.
Key Drivers Behind the Yield Movements
Fed Policy Decision
Investors are eagerly awaiting the Federal Reserve’s announcement later today, with markets anticipating a hold on interest rates, but guidance on future cuts will be critical. Should Fed Chair Jerome Powell adopt a dovish tone, U.S. Treasury yields could decline further, reinforcing a downward trajectory for Eurozone yields.
U.S. Tariff Escalation
Despite prior comments from U.S. Treasury Secretary Scott Bessent hinting at a delay, the White House reaffirmed that President Donald Trump’s new reciprocal tariffs remain set for activation on April 2. The trade tensions between the U.S. and Europe have fueled concerns over economic growth headwinds, prompting a flight to safe-haven assets like bonds.
Germany’s Historic Fiscal Shift
The Bundestag’s approval of massive public spending increases, particularly in defense and infrastructure, represents a fundamental departure from decades of fiscal conservatism. While this could stimulate medium-term growth, Fitch Ratings warned that Germany’s debt-to-GDP ratio could rise to 70% by 2027, the highest among AAA-rated nations. The market remains cautious about how this expanded borrowing will be managed over the next decade.
ECB Rate Expectations
Traders are now pricing in an ECB deposit rate of around 2% by December, with a 50% probability of a 25 bps rate cut as early as April. The easing expectations come as ECB officials continue to weigh softening inflation risks against economic uncertainty driven by U.S. tariffs and geopolitical concerns.
Outlook and Scenarios
Bullish Case (Lower Yields Continue): If the Fed signals potential rate cuts in the coming months, U.S. yields could decline further, dragging down Eurozone yields. Additionally, if U.S. tariffs weaken economic sentiment, bond demand could increase, reinforcing lower yields across Europe.
Bearish Case (Yields Rebound): Should Trump’s tariffs get postponed or the Fed signal a longer pause before cutting rates, bond yields could see a temporary rebound. The passing of Germany’s spending plan may also lead to higher long-term yield expectations, as markets adjust to an increase in German debt issuance.
Neutral Case (Range-Bound Yields): If the Fed maintains its current stance, but provides cautious language on rate cuts, and U.S. tariffs proceed as planned, Eurozone yields may stabilize near current levels, with Germany's 10-year Bund yield fluctuating between 2.75% and 2.90%.
Conclusion Eurozone bond markets are in a delicate balancing act, caught between monetary policy expectations, U.S. trade risks, and Germany’s fiscal expansion. While short-term downward pressure on yields remains intact, longer-term concerns about increased debt issuance and inflationary pressures may create volatility. Investors will closely watch the Fed’s tone later today, as it could set the direction for Eurozone yields in the coming weeks.
Market Reaction: Declining Yields Across the Eurozone Germany’s 10-year Bund yield dropped 4.5 basis points (bps) to 2.87%, reaching a session low of 2.748%, its lowest since March 5. This movement follows last week's peak of 2.938%, the highest since October 2023. The 2-year Bund yield, which is more sensitive to European Central Bank (ECB) rate expectations, also edged lower by 2 bps to 2.16%, reflecting ongoing speculation about potential monetary easing.
Meanwhile, Italy’s 10-year yield fell 3.5 bps to 3.83%, its lowest level since early March, after reaching a multi-month high of 3.997% last week. The spread between Italian and German 10-year bonds remained at 106 bps, a key gauge of investor risk perception regarding Italian debt. Similarly, the spread between French and German bonds stabilized at 67 bps, at the lower end of its recent range.
Key Drivers Behind the Yield Movements
Fed Policy Decision
Investors are eagerly awaiting the Federal Reserve’s announcement later today, with markets anticipating a hold on interest rates, but guidance on future cuts will be critical. Should Fed Chair Jerome Powell adopt a dovish tone, U.S. Treasury yields could decline further, reinforcing a downward trajectory for Eurozone yields.
U.S. Tariff Escalation
Despite prior comments from U.S. Treasury Secretary Scott Bessent hinting at a delay, the White House reaffirmed that President Donald Trump’s new reciprocal tariffs remain set for activation on April 2. The trade tensions between the U.S. and Europe have fueled concerns over economic growth headwinds, prompting a flight to safe-haven assets like bonds.
Germany’s Historic Fiscal Shift
The Bundestag’s approval of massive public spending increases, particularly in defense and infrastructure, represents a fundamental departure from decades of fiscal conservatism. While this could stimulate medium-term growth, Fitch Ratings warned that Germany’s debt-to-GDP ratio could rise to 70% by 2027, the highest among AAA-rated nations. The market remains cautious about how this expanded borrowing will be managed over the next decade.
ECB Rate Expectations
Traders are now pricing in an ECB deposit rate of around 2% by December, with a 50% probability of a 25 bps rate cut as early as April. The easing expectations come as ECB officials continue to weigh softening inflation risks against economic uncertainty driven by U.S. tariffs and geopolitical concerns.
Outlook and Scenarios
Bullish Case (Lower Yields Continue): If the Fed signals potential rate cuts in the coming months, U.S. yields could decline further, dragging down Eurozone yields. Additionally, if U.S. tariffs weaken economic sentiment, bond demand could increase, reinforcing lower yields across Europe.
Bearish Case (Yields Rebound): Should Trump’s tariffs get postponed or the Fed signal a longer pause before cutting rates, bond yields could see a temporary rebound. The passing of Germany’s spending plan may also lead to higher long-term yield expectations, as markets adjust to an increase in German debt issuance.
Neutral Case (Range-Bound Yields): If the Fed maintains its current stance, but provides cautious language on rate cuts, and U.S. tariffs proceed as planned, Eurozone yields may stabilize near current levels, with Germany's 10-year Bund yield fluctuating between 2.75% and 2.90%.
Conclusion Eurozone bond markets are in a delicate balancing act, caught between monetary policy expectations, U.S. trade risks, and Germany’s fiscal expansion. While short-term downward pressure on yields remains intact, longer-term concerns about increased debt issuance and inflationary pressures may create volatility. Investors will closely watch the Fed’s tone later today, as it could set the direction for Eurozone yields in the coming weeks.