Euro zone yields headed for weekly fall after Powell comments, await US data

Euro zone yields dropped on Friday ahead of U.S. jobs data and were headed for a weekly fall after Federal Reserve Chair Jerome Powell suggested interest rate cuts remained on the table, soothing fears of a possible hike by the U.S. central bank. Meanwhile, European Central Bank policymaker Yannis Stournaras, seen as a dove, backed market expectations for the central bank's policy path by saying it was "most likely" to cut rates three times this year.

Euro zone yields dropped on Friday ahead of U.S. jobs data and were headed for a weekly fall after Federal Reserve Chair Jerome Powell suggested interest rate cuts remained on the table, soothing fears of a possible hike by the U.S. central bank.

Meanwhile, European Central Bank policymaker Yannis Stournaras, seen as a dove, backed market expectations for the central bank's policy path by saying it was "most likely" to cut rates three times this year. 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 zone, fell 2 basis points (bps) to 2.53% and was set to end the week 5 bps lower. "Chair Powell explicitly noted that a material weakening in the labour market could precipitate rate cuts even if inflation were to remain relatively sticky and moderately elevated; those weren't his words, but that's the translation," said Padhraic Garvey, regional head of research, Americas, at ING.

Money markets are pricing in 70 bps of ECB monetary easing in 2024, not far from the levels seen just before Powell's speech and late last week. They imply two rate cuts and an 80% chance of a third move in 2024. Markets discount 39 bps of cuts by year-end from the Fed. Ten-year U.S. Treasury yields fell sharply on Wednesday after Powell said: "It is unlikely that the next rate move will be a hike."

But that optimism faded into the close of the U.S. session on Wednesday on Powell's warning that "further progress is not assured" on sustainably meeting the Fed's 2% inflation target. The yield spread between U.S. 10-year Treasuries and German bunds - a gauge of the expected policy path divergence between the ECB and the Fed - tightened to 204 bps.

Italy's 10-year yield was 3 bps lower at 3.84%. The gap between Italian and German 10-year yields - a gauge of the risk premium investors ask to hold bonds of the euro area's most indebted countries - was flat at 131.5 bps, close to its lowest level since March.

Market participants will focus on Fitch's review of Italy's credit rating after the European market closes. "A negative outlook seems possible today, but we consider it more likely that the rating agency will wait until more clarity on the next budget emerges," said Christoph Rieger, head of rates and credit research at Commerzbank.

He added that the Italian spread recently tightened "defying fundamental impulses."

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