Euro Zone Bond Yields Slide Amid Political Calm

Euro zone bond yields fell, especially in France and Italy, as political risk premiums were reduced following the French parliamentary elections. The yield spread between French and German bonds narrowed significantly. This adjustment reflects the market's reaction to reduced fears of the far right gaining power in France.

Euro zone bond yields experienced a notable decline on Wednesday, with significant drops observed in France and Italy. This movement indicates investors reducing the political risk premium associated with these countries in the lead-up to the French parliamentary elections. The closely monitored yield gap between French and German bonds, a measure of French risk, fell to its lowest point since mid-June, landing at 63.5 basis points (bps).

France's 10-year bond yield decreased by 9 bps, settling at 3.169%, following a 9 bps rise the previous day. In contrast, Germany's 10-year bond yield, the euro zone benchmark, dropped by 6 bps to 2.525% after a 4 bps increase on Tuesday.

'It's a continued correction of the sharp increase that we saw at the end of June,' remarked Jussi Hiljanen, head of rates strategy at SEB, 'Now it's normalizing.' The end-of-June surge in European yields, particularly in France, was driven by investor concerns over the potential rise of the French far right and its fiscal implications. Italian yields also ascended as investors avoided high-debt nations.

The hung parliament outcome, with strong results from the left bloc, helped ease some of the market's concerns. 'I don't see any very strong catalyst,' commented Emmanouil Karimalis, rates strategist at UBS. 'One day you sell off... We had (U.S. Federal Reserve chair Jerome) Powell yesterday, he didn't provide anything new but maybe his comments were on the hawkish side.'

Market participants await the U.S. CPI inflation data due on Thursday, along with the second day of Congressional testimony from Fed Chair Powell, who reiterated the need for more inflation control before rate cuts. Meanwhile, Italy's 10-year yield fell by 10 bps to 3.858%, and its yield gap with Germany reduced by 6 bps to 133 bps. Richard McGuire, Rabobank's head of rates strategy, cited New Zealand's prospect of rate cuts and weak Chinese inflation data as contributing factors. Germany's two-year bond yield, more sensitive to ECB rate expectations, also dipped by 3 bps to 2.901%.

(With inputs from agencies.)