Relief over a pause in an escalation of the trade war between the U.S. and China has given way to doubt over the two countries' ability to resolve differences.
The drop in the 2-to-10 year U.S. Treasury yield curve to its flattest in more than a decade – at 13 basis points early on Tuesday - was a reminder of the future economic slowdown and recession fears regardless of a breakthrough on trade.
Yields on short-dated U.S. Treasury notes rose above 5-year borrowing costs on Monday for the first time in more than a decade.
"The number one driver for global risk sentiment is the U.S.-China trade talks, which suddenly don't look as promising as they did over the weekend," Commerzbank strategist Christoph Rieger said.
"What sounds good at the dinner table becomes rather difficult at the negotiating table - the market now knows how to read Trump, he knows how to create big news at bilateral meetings but then when it comes to the nitty gritty it can be a very different story," he added.
The German 2-yr/10-yr bond yield spread tightened to 89 basis points, after the spread between 2-year and 10-year U.S. Treasury yields overnight was at its tightest level in 11 years at 14 bps.
Germany's 10-year bond yield hit a 4-1/2 month low of 0.279 percent.
German 10-year yields are also being pushed down by domestic concerns, said Rieger of Commerzbank, with European growth indicators sagging and Italian political concerns rumbling on in the background.
Data on Monday showed euro zone manufacturing activity expanded at its weakest rate in over two years in November provided further evidence that the bloc's economic growth is past its peak.
Meanwhile, Italian Prime Minister Giuseppe Conte will present a new budget proposal in the next few hours, he told the Avvenire daily, aiming to avoid a disciplinary procedure by Brussels.
Italian yields have dropped sharply in recent days on hopes that Italy finds a compromise with the EU on its budget plans.
Yields across the Italian curve were marginally higher in early Tuesday trade, but still close to two-month lows hit on Monday. (Reporting by Abhinav Ramnarayan; editing by Ed Osmond)
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