Euro zone government bond yields rise after Fed's Waller remarks

Waller said it was prudent to hold rates at the current restrictive levels for longer to help keep inflation on a sustainable trajectory toward 2%. France, Italy and the U.S. will issue inflation figures on Friday, while German and euro area-wide data is due next week.

Euro zone bond yields edged up on Thursday after Federal Reserve Governor Christopher Waller advocated a higher-for-longer rate strategy ahead of inflation data which could affect the central banks' policy path. Waller said it was prudent to hold rates at the current restrictive levels for longer to help keep inflation on a sustainable trajectory toward 2%.

France, Italy and the U.S. will issue inflation figures on Friday, while German and euro area-wide data is due next week. Some analysts argued that markets would need outsized surprises to shake confidence in the timing of the first ECB rate cut to be in June, while inflation figures could affect bets on further ECB rate cuts.

Money markets last fully priced in a 25 bps ECB rate cut by June and around 90 bps by year-end. Germany's 10-year bond yield, the benchmark for the bloc, was up 3.5 basis points (bps) at 2.33%, after hitting late on Wednesday 2.292%, its lowest level since March 12.

Some analysts argued that hawkish Fed comments provided bumps in the road for further easing of bond yields, but the prospects for benign consumer price prints could support Bund prices. Bond prices move inversely with yields. Bund yields were set to end the week roughly unchanged, the month down 8.5 bps and the first quarter up 28 bps.

At the end of December 2023, Bund yields hit their lowest levels in around one year as markets increased bets on future rate cuts to over 150 bps. In 2024, investors reduced their initial forecasts after strong economic data, and European Central Bank officials pushed back against market expectations for excessive monetary easing.

Yields in U.S. Treasuries fell on Wednesday before Waller's remarks, but the focus is on the U.S. core personal consumption expenditure (PCE) price index data for February, due on Friday. "The market could react in quite an asymmetric fashion to tomorrow's PCE release, with an above consensus print prompting quite a sharp repricing (i.e. removal of a June cut) while something lower than consensus will need to be reinforced by a second month's print for investors to gain confidence about pricing in more than 75 bps of 2024 cuts," Rabobank said in its morning note.

Italy's 10-year bond yield was up 9 bps at 3.70% , with the closely watched gap to Germany's 10-year yield at 136 bps, its highest since March 6. The yield gap -- a market gauge of risk premium investors ask to hold bonds of the euro area's most indebted countries -- has corrected sharply after hitting 115.40 in mid-March, its lowest in over 26 months.

Italian spreads recently tracked yield gaps tightening in the credit markets while turning a blind eye to Italian state sector budget deficit.

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