Euro zone bond yields inch higher as U.S. economy sends mixed signals

Euro zone bond yields rose on Friday after data showed inflation in the bloc climbed in December and the U.S. labour market beat predictions, putting them on track for the biggest weekly increase in months. Yet yields lost some ground late in the European day when ISM survey data showed that the U.S. services sector slowed considerably in December, with a measure of employment sliding.

Germany's 10-year bond yield was last up 3 basis points (bps) at 2.129% near the end of a volatile day's trading, down from a three-week high of 2.211% touched after the U.S. jobs data. It was still on track for its biggest weekly rise since mid-October, at 10 bps.

Yields, which move inversely to prices, have risen sharply so far this year as investors have tempered their expectations of big interest rate cuts in 2024 which had powered a bond market rally in November and December. Data on Friday showed that euro zone inflation rose to 2.9% year-on-year last month, from 2.4% in November, easing some of the pressure on the European Central Bank to start cutting rates.

Separate figures showed that U.S. non-farm payrolls rose by 216,000 in December, up from 173,000 in November. That was well above economists' forecast for 170,000. "Investors should see in this situation an occasion to take profits on their recent gains of November and December," Florian Ielpo, head of macro at Lombard Odier Asset Management, said.

"Growth remains in check, disinflation goes on while central banks are now friendlier than before." The U.S. 10-year yield was last down 3 bps at 3.966%, sharply below a three-week high of 4.103% touched just after the jobs data.

"The plunge in the ISM services index to a 7-month low in December suggests, at face value, that the economy is sliding into recession," Andrew Hunter, deputy chief U.S. economist at Capital Economics, said. Yet he said the reading has had a poor relationship with official U.S. growth figures in recent years and so "it probably makes sense to put more weight on the latest hard activity data".

Italian 10-year bond yields were up by around 2 bps at 3.793%, down from a high of 3.914% earlier in the session. Germany's two-year bond yield, which is sensitive to ECB rate expectations, was last up 4 bps at 2.557%.

December 2024 ECB euro short-term rate (ESTR) forwards were last at 2.42% - implying 148 bps of cuts in the ECB deposit facility rate this year - from 2.22% early on Thursday that had implied 168 bps of cuts. The current ECB deposit rate is 4%. Traders now see a roughly 50% chance that the ECB starts cutting rates in March, down from around 70% early on Thursday, according to money market pricing.

They see around 140 bps of cuts coming in the U.S. this year, down from above 150 last week, and now think there's a roughly 65% chance of the first Fed cut coming in March, compared with 75% a week earlier.