ECB Rate Cuts Loom: German Bonds Snap Inversion as Weak PMIs Sound Alarm
German Bond Yield Curve Normalizes Amid Bets on Faster ECB Rate Cuts
German two-year bond yields fell below 10-year yields in trading on the 23rd, erasing an inverted yield curve for the first time in nearly two years, as a faltering euro zone economic recovery has prompted speculation that the European Central Bank (ECB) will be forced to cut interest rates more quickly.
The yield on German two-year bonds fell more than the yield on 10-year bonds, pushing the spread into positive territory for the first time since November 2022. The United States and the United Kingdom, where monetary easing has begun, have also seen the resolution of inverted yield curves in the past.
The preliminary September euro zone HCOB composite purchasing managers’ index (PMI), released on the same day, fell below 50, the dividing line between economic expansion and contraction, for the first time since March, raising growing signs that the euro zone economy is entering a period of decline. Last week, the Bundesbank said Germany may already be in a mild recession.
German government bond yields had been inverted for about two years, with shorter-term bonds outperforming longer-term ones, as investors expected the ECB to continue tightening monetary policy.
But with euro zone inflation now at its lowest in three years and just above its target, and the U.S. Federal Reserve kicking off an easing cycle with a big half-percentage-point cut in interest rates, the case for further easing by the ECB has strengthened. Money markets are pricing in a 43 basis point cut from the ECB this year, up from 38 basis points at the end of last week.
German two-year bond yields have fallen 25 basis points this month alone to 2.14%, while 10-year yields have fallen 15 basis points to 2.15%.
French Bond Premiums Are Expanding
Meanwhile, the premium of French bonds over German debt widened as investors focused on the challenge and ability of Prime Minister Barnier’s new government to rein in France’s huge budget deficit.
The spread between benchmark 10-year French and German government bonds, used as a gauge of French risk, is at 80 basis points, the highest since early August. For the first time since the financial crisis, French 10-year bond yields are almost in line with lower-rated Spanish bonds.