Euro zone bond yields edge lower ahead of central bank meetings

Euro zone government bonds slipped on Monday ahead of a week packed with macro risk events, including rate decisions from the Federal Reserve, Bank of England and Bank of Japan, all of which could influence investor appetite for euro zone debt.

French bonds traded roughly in line with their German peers after lagging in early trade as credit ratings agency Fitch cut France's long-term rating on Friday. Borrowing costs rose on Friday after the ECB maintained an upbeat view on growth and inflation.

Germany's 10-year yield, the benchmark for the euro zone bloc, fell 2 basis points (bps) to 2.69%. Markets priced in a 45% chance of a 25 bps ECB cut by June 2026 to 1.75%, and a depo rate at around 1.9% in December 2026.

Some analysts remain cautious about market pricing for the ECB rate outlook, warning that expectations may be running ahead of fundamentals. "Lagarde sounded a bit hawkish last week, backing a higher-for-longer rate scenario," said Gabriele Foa, portfolio manager at Algebris Investments.

"Still, we expect possible ECB easing next year, especially after the Fed starts cutting rates and markets begin to feel the drag from U.S. tariffs and a strong euro." Germany's 2-year yields, more sensitive to expectations for European Central Bank policy rates, rose 1.5 bps to 2.00%.

The focus is now shifting to the Fed policy meeting outcome due on Wednesday. "A more political Fed in 2026, perhaps being comfortable with inflation running slightly warmer than 2%, could bring a fairly low bar for cuts to 2–2.5% in most positive economic states of the world," said Jason Williams strategist at Citi.

Markets are currently fully pricing a 25 bps Fed rate cut this week and around 140 bps by end 2026, from the current level of between 4.25% and 4.50%. France's OAT yields fell 2 bps to 3.49%.

The yield gap between safe-haven Bunds and 10-year French government bonds — a market gauge of the risk premium investors demand to hold French debt — was at 79 bps. Some analysts flagged that OATs are already trading markedly cheaper than double-A or single-A rated peers.

The premium investors demand to own French, rather than German bonds, traded above 80 bps on Monday, having risen from around 65 bps in the last month, as a vulnerable French government headed towards last week's confidence vote. "If France falls below AA- from two or more rating agencies, we could see some forced selling from institutional accounts," said Jefferies strategist Mohit Kumar.

President Emmanuel Macron last week named loyalist Sebastien Lecornu as France's fifth prime minister in under two years, after predecessor Francois Bayrou was toppled in the parliamentary confidence vote over the government's hugely unpopular budget.

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