Eurozone bond yields tumble, bets pile up for recession

Eurozone government bond yields fell on Friday (Jun 23) after data fuelled concerns about the flagging economy and expectations that the European Central Bank may not have the scope to raise rates much further.

Eurozone business growth virtually stalled this month as the downturn in manufacturing deepened, while activity in the 20-nation area’s dominant services industry barely expanded.

Two of the common currency zone’s major engines of growth –France and Germany – saw a decline in service sector activity and a deepening deterioration in manufacturing this month.

The ECB is thus left with a dilemma of whether or not to keep raising rates to force down inflation while the economy is all but stagnating.

In response, bond yields fell, with 10-year paper seeing a sharper decline than yields at the front end, which in turn pushed the curve to its most inverted in 35 years – one sign that investors are worried about the outlook for growth.

“The downturn in manufacturing is clearly deepening (particularly Germany at 41.0), and services are seeing a considerable loss of momentum ... or even dropping into contraction,” ADM Investor Services chief global economist Marc Ostwald said.

“Per se, the cushion that services demand has been providing against the manufacturing downturn is clearly running out of road, and raising the risk of recession in major economies in the second half of 2023,” he said.

Germany’s 2-year bond yield, the most sensitive to expectations for monetary policy, dropped 11 bps to 3.16 per cent, while 10-year yields fell 14 bps to 2.342 per cent, bringing the yield gap between the two maturities to its most inverted since September 1992.

“Financial markets have had one of those switches in the narrative that happen occasionally and are starting to worry about higher interest rates driving recessions,” said Paul Donovan, chief economist at UBS Global Wealth Management.

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An inverted curve, which is usually a reliable indicator of a future recession, means markets are pricing for events that could lead central banks to cut rates, such as a sharp slowdown in growth.

Money market showed traders were betting on the ECB deposit rate peaking at close to 4 per cent this year on Friday, after three other central banks raised rates the previous day.

The Bank of England raised rates by 50 bps and said there had been “significant” news suggesting British inflation would take longer to fall.

The Swiss National Bank and Norges Bank also tightened monetary policy and indicated they could do more.

Late on Thursday, US Chair Jerome Powell said the Federal Reserve would move interest rates at a “careful pace” from here.

December 2023 forwards on European Central Bank (ECB) euro short-term rate (ESTR) were at 3.88 per cent, implying market expectations for an ECB depo rate at 3.98 per cent by year-end.

Italy’s 10-year government bond yield, a benchmark for the euro area’s peripheral debt, fell 14 bps to 3.986 per cent, leaving their premium over German yields virtually unchanged on the day at 163 bps.

Greek government bonds underperformed the rest of the market ahead of an election weekend.

Greece’s 10-year yield was last up 1 bps at 3.612 per cent, leaving the spread between German and Greek 10-year yields a touch wider at 118 bps. REUTERS