Euro zone bonds steady after safe-haven rally, French debt set for best week since August

Euro zone government bond yields steadied on Friday but ‌were ​still set for a weekly decline, thanks to bonds' recent safe-haven rally sparked by concern about AI-related companies' ability to deliver a return on their vast spending. Global bonds are heading for their strongest weekly performance in four months, with yields on the sovereign debt of G7 economies down by an ‌average of 8.7 basis points to 4.273%, according to LSEG data.

The shares and bonds of more indebted companies linked to the artificial intelligence build out were hit hard earlier this week, which weighed on the broader equity market and pushed investors back into bonds. Yields on German 10-year Bunds, the safe haven of choice for many investors in European assets, have fallen nearly 7 bps this week to around 3.42% on Friday, though ‌were up 1 bp on the day. Two-year yields were 2 bps lower on Friday at 3.06%.

"Concerns about the AI boom are making government bonds look like better value," said analysts at Societe ‌Generale. However, "we have been here before" they cautioned, saying they doubted this was the end of the AI investment frenzy and the end of the cycle.

Government debt, which traditionally acts as a shock absorber for ructions in riskier assets, has been unable to perform this function for most of this year, as the surge in energy and food prices as a result of the Middle East war has forced investors to price in the prospect of higher borrowing costs in the form of higher ⁠yields. The correlation between ​Bunds and the STOXX 600, for example, has turned ⁠positive — meaning yields are more likely to fall when stocks fall and vice versa — this week for the first time since early August.

This relationship reached its most negative on record in late September, according to LSEG data. As well as the impact ⁠of the war in the Gulf, central bankers from the world's largest economies gathering in Bangkok said the AI boom was also creating fresh inflation pressures and financial risks, because the investment is arriving long before the productivity gains ​AI promises.

FRENCH DEBT STABILISES One of the major aggravating factors for bonds has been the persistent concern among investors about the long-term finances of developed-market governments.

Yields on French bonds, which have been ⁠among the most harshly punished in the past few weeks, given the deep-rooted worry about France's ability to tackle its finances, were trading around 4.79%, flat on the day, and down 7 bps this week, set for their largest weekly drop since early ⁠August. The ​premium of French 10-year yields over Bunds , a reflection of the extra compensation investors want for the risk of lending to France, rather than Germany, was around 137 bps on Friday, having fallen from a 15-year high of nearly 160 bps on October 2.

"We remain defensive on (French) OATs given the fiscal and political risks," said Soc Gen. "Beware of new waves of volatility as the budget debate ⁠is ongoing and investors are not keen to add a lot of risk."

Money markets show traders do not believe the ECB will raise interest rates at its meeting this month, but upped ⁠the chances of a December rate hike to 100%, ⁠from just below that level earlier in the day. At least one more hike is priced in by next April. There was little reaction to data that showed harmonised inflation in the euro zone ran at a five-year high of 3.8% in September, in line with expectations in a Reuters poll of economists.

The ‌IMF said in its regular ‌forecast for Europe it expects one more ECB rate hike this year.