Euro zone bond yields struggle for direction ahead of U.S. data

The U.S. Federal Reserve will hold off cutting rates until the fourth quarter of next year, according to Goldman Sachs economists who cited stronger-than-expected economic growth that is helping forestall a recession. Italy's 10-year government bond yield, the benchmark for the euro area's periphery, dropped 1.5 bps at 4.55%.

Euro zone government bond yields struggled for direction on Tuesday as investors await U.S. inflation data, which could affect the Federal Reserve policy outlook.

Analysts said euro area borrowing costs would keep tracking U.S. Treasury yields, while remarks from European Central Bank (ECB) officials pushing against expectations for rate cuts offset the impact of a bleak economic outlook in the bloc. ECB president Christine Lagarde, when asked how long rates would have to stay at high levels to win the battle against inflation, said in an interview during the weekend that no change should be expected in the "next couple of quarters".

Money markets recently scaled back their bet on future rate cuts, but they still fully price in a 25 basis points (bps) reduction by June. They also discount 83 bps of cuts by the end of 2024, from 100 bps on Nov. 2. Economists expect the ECB to hold interest rates steady well into next year, with most polled by Reuters sticking to forecasts that the first cut will have to wait until at least July despite expectations of a euro zone recession.

Germany's 10-year government bond yield, the benchmark for the euro area, was down 0.5 bps at 2.71%. "Our economists expect a 0.34% month-on-month increase in (the U.S.) core consumer price index (CPI) for October, a little above the rounded consensus of 0.3%, which is likely still not strong enough to prompt a December rate hike," Citi said in a research note.

"However, they do not rule out a strong 0.4% increase that could keep a hike on the table." Wall Street economists expect the headline consumer price index (CPI), reported on Tuesday, to have slowed to a 0.1% rise in October from a 0.4 increase in September, according to a Reuters poll. The core inflation number is expected at 0.3% last month, unchanged from September.

"Our economists see less downside and more upside potential in view of the accelerating rise in rents, a bounce in used car prices and the methodological changes in health insurance cost," said Christoph Rieger, head of rates research at Commerzbank. The U.S. Federal Reserve will hold off cutting rates until the fourth quarter of next year, according to Goldman Sachs economists who cited stronger-than-expected economic growth that is helping forestall a recession.

Italy's 10-year government bond yield, the benchmark for the euro area's periphery, dropped 1.5 bps at 4.55%. The gap between Italian and German 10-year yields - a gauge of the risk premium investors ask to hold bonds of the euro zone's most indebted countries - was 182 bps. It dropped to 179.90 the day before as Fitch kept Italy's BBB credit rating unchanged, with a stable outlook.

Moody's - which rates Italy one notch below Fitch and S&P, and one notch above the investment grade level with a negative outlook – will update its assessment on Friday. Still, most analysts do not expect Italy to lose its investment grade rating in the absence of a domestic political shock.