Bund yield ticks higher after mixed week for data, U.S. PPI eyed

The yield on the euro zone benchmark rose 4 basis points (bps) to 2.39%, not far from Tuesday's two and a half month high of 2.415%, hit after higher than expected U.S. inflation data sent bond yields up on both sides of the Atlantic, as markets pushed back expectations of how soon central banks will cut interest rates. Germany's 10 year yield was little changed on a weekly basis however, as other data including Thursday's softer than expected U.S. retail sales figures, and Wednesday's lower than expected British inflation data complicated the global picture somewhat.

Germany's 10-year bund yield edged up on Friday, leaving it a fraction higher on the week and around its highest since early December, as traders digest the week's mixed bag of global data and what it means for central bank policy. The yield on the euro zone benchmark rose 4 basis points (bps) to 2.39%, not far from Tuesday's two and a half month high of 2.415%, hit after higher than expected U.S. inflation data sent bond yields up on both sides of the Atlantic, as markets pushed back expectations of how soon central banks will cut interest rates.

Germany's 10 year yield was little changed on a weekly basis however, as other data including Thursday's softer than expected U.S. retail sales figures, and Wednesday's lower than expected British inflation data complicated the global picture somewhat. Bonds' yields move inversely to their prices.

"We think that European rates will remain under pressure in the coming weeks amid stronger global data and policy rate uncertainty," said Emmanouil Karimalis, European rates strategist at UBS in a Friday note. "Nevertheless, we anticipate buying interest to pick up, if 10y bunds move closer to 2.5% levels."

The main data event for Friday is U.S. producer price, or factory gate, inflation figures, which Deutsche Bank strategist Jim Reid said was "the most important U.S. PPI print for a while ... (as it will) provide an update on some key services components of PCE inflation". PCE inflation is the U.S. Federal Reserve's preferred inflation measure and it has diverged somewhat from consumer price inflation in recent months.

Government bonds around the world are highly sensitive to expected changes in central bank policy at present. Those expectations are close to moving in unison as markets think most major central banks would prefer to keep their policy roughly aligned with that of the Fed, and because of the global nature of the post COVID inflation surge and its recent decline. Market pricing reflects roughly a 50% chance of a 25 bp rate cut by the European Central Bank at its meeting in April, and is fully pricing in 50 bps of cuts across the ECB's April, June and July meetings.

A March cut, now seen as highly unlikely, had been all but priced in late 2023, and that change led to the sell-off in government bonds this year. Investors were also digesting the latest remarks from policy makers. ECB member and Bank of France head Francois Villeroy de Galhau told Belgian paper L'Echo that the ECB should not hold off for too long on an initial interest rate cut.

Villeroy added the ECB had "three degrees of freedom" regarding its future monetary policy, namely the timing of the first rate cut, the pace of further monetary policy easing afterwards and then the level to which rates could fall. In contrast, ECB policymaker Isabel Schnabel said the ECB must be cautious about adjusting its policy stance prematurely.

Italy's 10-year yield, the benchmark for the euro zone periphery was about 2 bps higher at 3.87%, around 11 bps off its two month high also hit Tuesday after the U.S. inflation print. It is heading for a weekly fall of nearly 10 bps, helping the closely-watched spread between German and Italian 10 year yields to narrow to 147.3 bps on Friday, close to its narrowest in two years.

"Despite the challenging market conditions, including the repricing of ECB policy rate expectations and record-high January supply, peripheral spreads have remained resilient," said Karimalis. He said peripheral bonds' current prices were attractive, demand was high, and the overall risk environment was supportive.