German government bond yield falls, Fed in the background

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MILAN — German bond yields edged lower on Friday, tracking moves in U.S. borrowing costs, and analysts expect the adverse reaction of euro zone bond prices to a hawkish policy meeting of the Federal Reserve this week to prove short-lived.

The U.S. curve flattened after an initial spike in yields on Thursday, as some investors appeared to have been caught flat-footed by the Fed comments. Investors who had been betting on yield curve steepening after the Fed statements scrambled to cover those trades.

The U.S. 10-year government bond yield was down 1.5 basis points at 1.5% in early London trade.

“The eurozone government market will be in a wait-and-see mode today, with an eye on U.S. Treasury yields,” said Andrea Ponti, co-head of fixed income portfolio management at Kairos Partners.

“But after yesterday’s bond selloff, the focus is shifting to the ECB’s ultra-dovish stance, with investors not forecasting any bond-buying tapering discussion before the fall,” he added.

Germany’s 10-year government bond yield fell 1 basis point to 0.2%.

According to Unicredit analysts, “after a turbulent week, we expect the next several days to see a modest increase in U.S. real rates, to which EGB yields should remain rather immune.”

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Periphery bond prices continued to underperform core bonds as they have benefited most from the ultra-accommodative monetary policy to avoid the pandemic’s adverse economic impact.

Italy’s 10-year government bond yield rose 0.5 basis point to 0.835%.

“Markets still seem to be getting to terms with the new Fed reality. Curve dynamics, in particular, stand out with 10-30y U.S. Treasuries switching from aggressive bear-flattening after the FOMC to bull-flattening during yesterday’s recovery,” Commerzbank told clients.

Besides, the “capitulation of 10y TIPS break-evens to the lowest level since end-March amid steady real yields is leaving inflation expectations as Powell’s major victim,” they said, adding that they seem “misguided in the current situation.”

According to Deutsche Bank economist George Saravelos, this notable drop in inflation expectations “is telling us that the market is taking an extremely pessimistic view on real neutral rates.” (Reporting by Stefano Rebaudo, editing by Gareth Jones)