Euro area benchmark Bund yield close to 11-week high ahead of US data

The euro area's benchmark Bund yield edged higher on Tuesday to within striking distance of its highest levels in almost 11 weeks ahead of crucial U.S. inflation data as investors recently trimmed expectations for future rate cuts.

The euro area's benchmark Bund yield edged higher on Tuesday to within striking distance of its highest levels in almost 11 weeks ahead of crucial U.S. inflation data as investors recently trimmed expectations for future rate cuts. Remarks from rate-setters on both sides of the Atlantic warning that central banks must be cautious in easing monetary policy have led investors to scale back bets on rate cuts in the eurozone in 2024 to around 120 basis points (bps), from 150 bps at the end of January.

European Central Bank policymaker Fabio Panetta -- among the most dovish members on the committee -- said on Monday that the time for a reversal of the bank's stance was fast approaching, but that it might take some more soft data. Market participants label as hawks central bank officials who advocate a tight monetary policy to control inflation, while doves focus more on economic growth and the labour market.

Germany's 10-year bond yield, the benchmark for the euro area, was down 1.5 bps at 2.35%. It hit 2.39% late Friday, its highest level since Dec. 1. Germany is not in recession, and its economy is expected to grow in 2024, Chancellor Olaf Scholz's chief of staff, Wolfgang Schmidt, said on Tuesday. The ZEW economic research institute said German investor morale has improved in February.

Analysts argued that the year-on-year U.S. inflation rate will fall because of a base effect, as in January 2023 there was a 0.5% increase in the month. "If we get the anticipated 0.3% (month-on-month rise in core inflation), we doubt there can be a positive reaction," said Padhraic Garvey, regional head of research Americas.

"For the market to conjure up a positive reaction to the inevitable fall in year-on-year rates, there needs to be a 0.2% month-on-month outcome for core," Garvey added. RATE CUT?

Markets are currently pricing in around a 50% chance of a U.S. rate cut in May, according to CME Group's FedWatch Tool. Investors will remain focused on U.S. data, which could provide clues about the monetary policy path as they await additional economic data.

"This coming release (of U.S. inflation data) will play an important role in deciding the path of monetary policy in the first half of the year," said Will Hobbs, head of UK multi-asset wealth at Barclays Private Bank & Wealth Management. "However longer-term investors can afford to step back from the frenzy – those aforementioned trends in productivity are what matter," he added.

January's U.S. Consumer Price Index (CPI) is due later on Tuesday, and the Producer Price Index is scheduled to be released on Friday. Other data late in the week include retail sales and the University of Michigan consumer survey. "The slow progress in year-on-year rates and the month-on-month dynamics for (U.S.) core inflation still above target is unlikely to provide lasting relief for the market," said Michael Leister, head of interest rates at Commerzbank.

Bond prices move inversely with yields. The Italian government bond 10-year yield -- the benchmark for the euro area's periphery -- was down 3 bps at 3.88%. The gap between Italian and German 10-year yields was at 152 bps. It hit 160.3 bps early this month, its widest level since Jan. 18.

Bond prices of highly indebted countries have recently benefited from expectations of quick monetary easing and the ECB's gradual wind-down of the Pandemic Emergency Purchase Programme (PEPP) reinvestments announced in December.