Germany's 10-year Bund yield set for biggest weekly fall since March

Throughout May and the start of June, demand for riskier southern European government bonds rose and demand for safer German debt declined as markets rallied on optimism that there would be an economic recovery. But the bullish sentiment in European government bond markets collapsed on Friday, following a sell-off in equities on Thursday that saw three major U.S. stock indexes fall more than 5%.

European bond markets steadied on Friday, after riskier debt sold off at the start of the session as the market turned more cautious, with Germany's 10-year government bond yield on track for its biggest weekly fall since late March. Throughout May and the start of June, demand for riskier southern European government bonds rose and demand for safer German debt declined as markets rallied on optimism that there would be an economic recovery.

But the bullish sentiment in European government bond markets collapsed on Friday, following a sell-off in equities on Thursday that saw three major U.S. stock indexes fall more than 5%. The change in sentiment was partially attributed to concerns that re-opening economies would cause a second wave of COVID-19. About half a dozen U.S. states are grappling with a rising number of coronavirus patients filling hospital beds.

Rabobank strategists said in a note to clients that the concern about a second wave and the Fed's bleak economic outlook on Wednesday are not the only factors driving the turnaround. "We'd argue that the market has been willing to look through such negative factors for some weeks. Instead, yesterday's moves may have been as much about some investors deciding to take some money off the table simply due to the recent stellar performance of equities and this snowballing over the course of the day," they wrote.

The fact that, during the risk-off move, the risk premium that Italian government bonds (BTPs) pay did not dramatically increase, shows that the European Central Bank's asset purchases are supporting the riskier debt, Commerzbank rates strategists said. "The relative resilience of the periphery is telling with 10y BTP spreads widening just 2bp in the risk-off rally, underlining the ECB support," they wrote in a note.

Banks in the eurozone will repay 214 billion euros ($241.65 billion) of ECB funding early, the ECB said on Friday, probably to roll the cash into a new facility at even more favorable terms. Italy's 10-year government bond yield, which rose to as much as 1.49% earlier in the session, was at around 1.45% at 1100 GMT, little changed on the day. while Portugal and Spain's 10-year government yields were also broadly flat.

The spread between Italian and German 10-year government yield spreads widened by around 2 basis points and is heading for its biggest weekly increase in 8 weeks. Demand for safer German government debt was little changed, with the 10-year yield at 0.415%. The yield has fallen around 14 bps this week. ($1 = 0.8856 euros)