Demand for safe European government debt rises as investors turn cautious

Demand for safe European government debt rose on Thursday, with Germany's 10-year bund yield down around 2 basis points, as Wednesday's risk-off mood extended through the Asian session. Investors turned cautious as rising coronavirus cases stoked fears of a second wave of infection, the IMF slashed its global output forecasts, and the U.S. flagged European products worth $3.1 billion as potential targets for future tariffs.

Demand for safe European government debt rose on Thursday, with Germany's 10-year bund yield down around 2 basis points, as Wednesday's risk-off mood extended through the Asian session.

Investors turned cautious as rising coronavirus cases stoked fears of a second wave of infection, the IMF slashed its global output forecasts, and the U.S. flagged European products worth $3.1 billion as potential targets for future tariffs. Florida, Oklahoma, and South Carolina reported record increases in new cases on Wednesday. Seven other states had record highs earlier in the week and Australia posted its biggest daily rise in infections in two months.

The risk-off mood is expected to continue ahead of U.S. unemployment data due at 1230 GMT. "As risk sentiment falters, cross-market correlations remain choppy with Bunds only getting a delayed lift from risk-off inequities," wrote Commerzbank rates strategists in a note to clients.

"The relatively muted reaction in spreads to risk-off underscores the resilient backdrop for the periphery," they added. Germany's benchmark 10-year Bund yield was at -0.453% at 0700 GMT, down 2 bps but still trading within the week's range.

Riskier Italian government debt sold off slightly, with the 10-year yield at 1.352%, up around 1 basis point. Spanish and Portuguese yields were little changed.

The spread between Germany and Italy's 10-year bond yields widened by around 5 bps. EU leaders remain divided on how to structure a proposed COVID-19 recovery fund for European economies, with the balance of loans and grants still to be agreed upon.

On Wednesday evening, European Central Bank policymaker Pablo Hernandez de Cos called for the recovery fund to be approved as soon as possible. The ECB agreed to give German authorities vital documents to prove the proportionality of the central bank's policies, two sources said, in a move to defuse the challenge to the bank's power.

Germany's Constitutional Court ruled in May that the ECB overstepped its mandate with over 2 trillion euros of government bond purchases, ordering the Bundesbank to quit the scheme unless the ECB can prove proportionality within three months.