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July 1 (Reuters) - Euro zone bond yields tumbled on Friday as traders shrugged off a record inflation reading and instead stormed into government debt on renewed fears of a recession.
The moves lower accelerated in the afternoon session after U.S. Treasury yields tanked, not helped by data showing U.S. manufacturing activity slowed more than expected in June.
The drop in yields came as euro area inflation hit a record high of 8.6% in June. The reading failed to trigger forecasts of a more aggressive monetary tightening path.
“Rates remain around their recent lows as inflation data did not bring relief to investors’ concerns on growth,” said Luca Cazzulani, head of strategy research at UniCredit.
Spreads between peripheral and core government bond yields narrowed, as expectations that the European Central Bank would step in with support to help peripheral countries grew.
Germany’s 10-year government bond yield slipped nearly 20 basis points (bps) from Thursday’s close to as low as 1.16%, its lowest since June 1, after rising briefly to as high as 1.41% following the inflation data.
Two-year yields also dropped sharply, losing more than 30 basis points since Monday in their biggest weekly decline since March.
According to ING analysts, “with a high risk of the euro zone economy falling into technical recession towards the end of the year and inflation coming down in 2023, there will be hardly any room for the ECB to deliver additional hikes in 2023.”
Italy’s 10-year bond yield dropped as much as 20 bps to 3.19% before recovering. The spread between Italian and German 10-year yields was last at 196 bps.
In the United States, benchmark Treasury yields skidded more than 20 basis points to around 2.8%, one of the biggest one-day moves since 2020.
Analysts flagged a divergence between yield spreads of government bonds and the credit market.
The Italian-German spread showed resilience recently, as it kept fluctuating around 200 bps.
At the same time, the iTraxx Europe Crossover index, which measures the cost of insuring exposure to investment grade European corporate high yield bonds, rose above 120 basis points on Thursday for the first time since March 2020.
“The major decoupling from credit spreads suggests that so far the ECB’s anti-fragmentation efforts are achieving the desired effect,” Commerzbank analysts said.
The ECB announced in mid-June plans to tackle fragmentation in euro zone bond markets, or an excessive widening of spreads between core and peripheral yields, that might hamper monetary policy transmission across the bloc.
The bank is on course to lift its rates out of negative territory but any hike beyond that will depend on incoming data as the outlook is uncertain, ECB board member Fabio Panetta said on Friday.
Money markets are pricing in around 140 basis points of European Central Bank rate hikes by year-end, down from about 155 bps earlier this week.
ECB policymaker and fiscal hawk Robert Holzmann was cited as saying on Thursday that he would prefer to take earlier action on rates rather than in July as planned.
Reporting by Stefano Rebaudo Additional reporting by Tommy Reggiori Wilkes Editing by Vinay Dwivedi and Angus MacSwan
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