Euro zone yields fall as Taiwan jitters boost demand in safe-haven assets

Aug 2 (Reuters) - Euro zone government bond yields fell on Tuesday as concerns about an escalation in Sino-U.S. tension drove investors into safe-haven assets.

U.S. House of Representatives Speaker Nancy Pelosi was set to visit Taiwan, as the United States said it wouldn’t be intimidated by Chinese threats to never “sit idly by” if she made the trip to the island, claimed by Beijing.

“As the news flow on gas is taking a breather, the market focus is shifting to the next potential major geopolitical story, Taiwan,” Commerzbank analysts said, referring to the reduction in Russian natural gas supplies to Europe amid the Ukraine conflict.

Germany’s 10-year government bond yield, the benchmark of the bloc, fell 4.5 basis points (bps) to 0.72%, after hitting its lowest since April 11 at 0.701%.

“The upshot for Bunds is similar to gas: In doubt, don’t be short,” the Commerzbank analysts added.

Euro zone bond yields have fallen since mid-June with investors scaling back their expectations about European Central Bank’s rate hikes on recession fears.

“We’ve been buying bonds for a couple of months as we thought markets overpriced forecasts about ECB monetary tightening,” said Massimiliano Maxia, a senior fixed income specialist at Allianz Global Investors.

“Now, it might be the right time to consolidate around the current levels. But the mood can change quickly also because markets will continue to be data-dependent,” he added.

Italy’s 10-year government bond yield fell 4 bps to 2.934%, after hitting its lowest since May 27 at 2.894%.

The closely watched spread between Italian and German 10-year bond yields was at around 220 bps, its tightest since July 21.

Italian government bonds have outperformed their peers since last Friday when data showed that the gross domestic product (GDP) of the euro zone’s third-largest economy grew faster than expected in the second quarter.

GDP increased 4.6% on a year-on-year basis and was well above its pre-COVID level, reducing the risk-premium for Italian bonds.

Political risks remain subdued, with some analysts arguing that the country’s right-wing coalition was unlikely to distance the country from the European Union as it would be very unwise to pick a fight with the EU and jeopardize the receipt of funds from the EU recovery plan known as the NGEU.

A bloc of conservative parties, led by the far-right Brothers of Italy, looks likely to win a clear majority at the ballot, according to recent opinion polls.

But ING analysts warned that recent spread tightening might be “precarious.”

“Hopes of the Italian front-runners skirting the sensitive issues of NGeu-mandated reforms and fiscal consolidation may prove too optimistic,” they said.

“Although we are sympathetic with the view that it may not be in their interest to alarm markets and voters, in the run-up to the elections,” they added.

The ECB is not able or willing to address the risks of a widening in the Italian and German bond spread as a result of Italian domestic politics through its Transmission Protection Instrument, they argued.

The TPI is a bond purchase scheme aimed at helping more indebted countries and preventing financial fragmentation, namely an excessive spread widening which might hamper monetary policy transmission across the currency bloc. (Reporting by Stefano Rebaudo, editing by Christian Schmollinger)