Government bond investors on hold after scaling back bets on rate cuts

Government bond investors were on hold on Thursday, with the euro zone yields well supported close to their highest levels in around one month in a data-light session and as the European Central Bank enters its quiet period before next week's meeting. Money markets scaled back their bets on rate cuts in the first half of 2024 on Wednesday after remarks from ECB officials and solid economic and inflation figures.

Government bond investors were on hold on Thursday, with the euro zone yields well supported close to their highest levels in around one month in a data-light session and as the European Central Bank enters its quiet period before next week's meeting.

Money markets scaled back their bets on rate cuts in the first half of 2024 on Wednesday after remarks from ECB officials and solid economic and inflation figures. Members of the ECB governing council must avoid making comments that could influence expectations about monetary policy in the seven days before a rate-setting meeting.

The central bank will also publish the minutes of the December meeting, when it decided to bring forward the timing of the pandemic Emergency Purchase Programme's (PEPP) roll-off and signalled that rate cuts were not on the table. Germany's 10-year government bond yield, the benchmark for the euro area, was up 0.5 basis points (bps) at 2.28%. It hit 2.293% on Wednesday, its highest level since Dec. 5.

"The (Bund) sell-off may have further to run near-term, but ultimately average around current levels to end-March," Citi rates strategists said in a research note. "We expect growing de-coupling (of Bund yields) to near-term rate cut prospects given: easing is likely, just pushed out; the risk that the ECB waits too long and then has to start quickly; and still stable inflation risk premium," they added.

Bond prices move inversely with yields. German 2-year yields, sensitive to expectations for policy rates, fell 1.5 bps to 2.67%, after briefly hitting a fresh one-month high at 2.693%.

U.S. economic data, due later in the session, will be in focus after retail sales on Wednesday dented expectations for early Fed rate cuts, sparking a bond sell-off. Money markets bets implied 138 bps of ECB rate reductions in 2024, including an 80% chance of a first move in April, and a less than 20% chance in March. They are all roughly in line with the levels seen late on Wednesday.

Italy's 10-year government bond yield, the benchmark for the euro area's periphery, dropped 1.5 bps to 3.89%. The gap between Italian and German 10-year yields was at 160 bps. Peripheral bonds still benefit from solid demand from investors keen on locking in yields that are close to their highest levels in over a decade.