Euro zone bond yields dip as rally resumes before Fed meeting

Credit: REUTERS/KAI PFAFFENBACH

Euro zone bond yields dipped on Monday as investors eyed more U.S.-China trade talks and waited for a likely U.S. Federal Reserve interest rate cut, after the European Central Bank's dovish signalling last week disappointed some.

By Tommy Wilkes

LONDON, July 29 (Reuters) - Euro zone bond yields dipped on Monday as investors eyed more U.S.-China trade talks and waited for a likely U.S. Federal Reserve interest rate cut, after the European Central Bank's dovish signalling last week disappointed some.

Core euro zone government bonds remain in demand and yields are trading just above record lows hit last week after the ECB on Thursday flagged another round of easing.

While yields then bounced higher on concern that not all ECB policymakers were agreed on the timing of new stimulus, the bond rally resumed on Monday.

Italian yields were the exception and did not fall as uncertainty about a possible snap general election weighed on sentiment.

The Federal Reserve begins its two-day monetary policy meeting on Tuesday, with a 25 basis point cut fully priced in.

Investors will be looking for whether the Fed signals that the rate cut is a one-off or the start of a longer rate-reducing cycle, as central banks look to fight signs of an economic downturn and lift inflation.

Sebastian Fellechner, an interest rate strategist at DZ Bank, said there was some risk aversion in financial markets on Monday as traders watched the latest round of U.S.-China trade negotiations.

But "for European government bond markets, the most important thing is the anticipation of a QE (quantitative easing) programme. That will drive yields lower," he added.

Fellechner thinks the ECB will signal more QE asset purchases in September, and launch stimulus before the end of 2019.

The benchmark German 10-year Bund yield fell more than 1 basis point to -0.3920% DE10YT=RR, not far from the record low of -0.422% touched last week. The 30-year Bund's yield was 2 bps lower at 0.183% DE30YT=RR.

French FR10YT=RR and Austrian AT10YT=RR yields also weakened.

Not everyone thinks the huge rally in bond markets seen in the last few months as investors snapped up government debt in anticipation of ECB easing has further to run.

"With the ECB having laid down the broad scheme of action at last week's meeting, recent lows in 10Y Bund yields are not likely to be re-tested soon unless economic data show marked negative surprises," Unicredit analysts said in a research note.

"Hints that the road to a decision is still a long one are likely to negatively affect EGBs (European government bonds), with doubts about QE proving especially negative for BTPs (Italian government bonds)."

Italian bonds rallied early on Monday but then fizzled. The 10-year bond yield fell 4 bps to 1.532% IT10YT=RR before rising to trade flat at 1.579%. Shorter-dated Italian yields IT2YT=RR, IT5YT=RR were unchanged.

Spanish bonds were in focus as the Socialist party sought to avoid a repeat election while at the same time ruling out a coalition deal with the far-left Podemos party.

Yields on Spanish debt fell marginally ES2YT=RR, with the 10-year bond yield at 0.371% ES10YT=RR.

(Editing by Catherine Evans and Jan Harvey)

((thomas.wilkes@tr.com; Reuters Messaging: thomas.wilkes.thomsonreuters.com@reuters.net))

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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