Euro zone yields drop, this week's US inflation data, ECB meet in focus

Pricing currently reflects around a 50% chance the Fed moves in June, according to CME's Fedwatch tool. Market expectations that the ECB could cut interest rates before the Fed has caused the gap between German and U.S. 10 year yields to widen.

Euro zone bond yields dipped on Tuesday to stand a touch below the previous day's three-week high, with attention firmly fixed on U.S. inflation data and a European Central Bank meeting due later in the week. Germany's 10-year yield was down 5 basis points at 2.39%. The eurozone benchmark hit a three-week high of 2.457% on Monday but has been trading in a fairly narrow range since mid-February, as traders wait to become more confident that slowing inflation will allow central banks to cut interest rates in the coming months.

The European Central Bank meets on Thursday. Any change in rates at this meeting would come as a major surprise. Rather, the focus will be on how President Christine Lagarde presents rate setters' thinking about future moves. Market pricing reflects around a 90% chance that the European Central Bank cuts rates by 25 basis points at its June meeting. Three such cuts are currently fully priced for 2024.

"The ECB will take great heart from headline inflation falling to 2.4%. The core now is now (under) 3%, the lowest in some time. I think they are quite intent on cutting rates by June," said Guy Miller chief market strategist at Zurich Insurance Group. "What will be interesting is what happens on Wednesday when we get the CPI numbers in the U.S. because inflation tends to have a global dynamic to it," he added.

Surprisingly strong numbers in the U.S. in combination with higher oil prices may give the ECB pause to reflect. A high U.S. inflation print would also likely push back expectations for the first Federal Reserve rate cut to July. Pricing currently reflects around a 50% chance the Fed moves in June, according to CME's Fedwatch tool.

Market expectations that the ECB could cut interest rates before the Fed has caused the gap between German and U.S. 10 year yields to widen. It is currently near its widest since early November 2023 at around 200 bps. The U.S. benchmark 10 year Treasury yield reached 4.464% on Monday, its highest since November. On Tuesday it dipped 3 bps to 4.39%.

Italy's 10 year yield, the benchmark for the euro zone periphery, was down 6 bps to 3.74%, leaving the closely watched spread between German and Italian 10 year yields at 133 bps.