Euro zone bonds set for best month in over a year as inflation drops

Bonds have surged in November, with U.S. Treasuries set for their biggest monthly rise since 2008, as a drop in inflation in the U.S. and Europe has stoked bets that central banks will soon be cutting interest rates. Data on Thursday showed that euro zone inflation slowed to 2.4% year on year in November from 2.9% in October, well below expectations of a fall to 2.7%.

Euro zone bond prices held on to recent gains on Thursday as inflation data in the currency bloc came in lower than expected, putting them on track for the biggest monthly rally in well over a year. Bonds have surged in November, with U.S. Treasuries set for their biggest monthly rise since 2008, as a drop in inflation in the U.S. and Europe has stoked bets that central banks will soon be cutting interest rates.

Data on Thursday showed that euro zone inflation slowed to 2.4% year on year in November from 2.9% in October, well below expectations of a fall to 2.7%. Germany's 10-year bond yield, the benchmark for the bloc, was little changed at 2.43%. Yields move inversely to prices.

The yield was on track for its biggest monthly drop since July 2022, at 38 bps, reflecting the strong rally in prices. An index of euro government bonds has climbed 3.2% in November, in the biggest monthly rise in a year and a half.

"Falling inflation and a stagnant economy could justify ECB cuts as soon as the first quarter of next year in our view," said Matthew Landon, global market strategist at JPMorgan Private Bank. "Against that backdrop, European bonds continue to offer a compelling entry point even after the big rally we have seen over the last month."

Also in the mix was U.S. data, which showed consumer spending rose moderately in October, while the annual increase in the PCE price index, a measure of inflation, was the smallest since early 2021. The signs of cooling demand could reinforce expectations that the Federal Reserve's interest rate hiking campaign was over, though the immediate market reaction was fairly muted.

MARKETS EXPECT APRIL RATE CUT Separate figures on Thursday showed that German unemployment rose in November and the French economy contracted in the third quarter, bolstering investors' bets that the European Central Bank will cut interest rates early next year.

Traders on Thursday moved to fully price in the first 25 bp interest rate cut in April, according to pricing in derivatives markets. They had previously seen a roughly 70% to 90% chance of such a move for most of November, after a drop in inflation in October. Germany's 2-year bond yield, which is sensitive to ECB interest rate expectations, was last down 3 bps at 2.79%, around its lowest since early June.

"Policymakers won't want to declare victory prematurely and are sure to reiterate at December's ECB meeting that it is far too early to cut rates," said Andrew Kenningham, chief Europe economist at Capital Economics. "Nonetheless, with headline and core inflation likely to trend down in the new year it will be hard for the ECB to ignore the extent to which the inflationary tide is turning."

Italy's 10-year bond yield was last up 3 bps at 4.21%. It was on track to fall 51 bps in November, its biggest monthly drop since the middle of 2019. The rally in global bonds, which slowed last week, picked up pace on Tuesday after Federal Reserve official Christopher Waller suggested that U.S. rate cuts could be coming in early 2024.

The U.S. 10-year Treasury yield was on track to fall around 58 bps in November, the biggest drop since late 2008, when the Fed was cutting interest rates during the financial crisis.