Euro Area Bonds React to Inflation and U.S. Trade Tensions

Euro area bond yields experienced a drop on Tuesday following weaker-than-anticipated French inflation data and lingering concerns over potential economic disruptions from U.S. tariffs. The fluctuation comes after borrowing costs rose on Monday when the U.S. rescinded its 50% tariff threat on European imports, before settling due to worries in the U.S. Treasury market regarding erratic U.S. trade policies. May witnessed French inflation decreasing to its lowest point since December 2020, mainly due to a steep decline in energy costs and slowing service charges.

Germany's 10-year government bond yield, a reference point for the euro area, dipped 2.5 basis points to 2.54%, marking its lowest since May 8. U.S. stock index futures rose on Tuesday as tensions between the U.S. and EU diminished, prompting a selloff in safe-haven bonds. Meanwhile, the euro zone is anticipating further inflation data from Germany, Italy, and Spain on Friday. European Central Bank (ECB) member Francois Villeroy de Galhau indicated that interest rate normalization in the euro zone is likely incomplete, though Austrian central bank governor Robert Holzmann has advocated for pausing rate cuts until September. Markets are pricing a 90% likelihood of an ECB 25 basis point rate cut next week, with expectations of a depo rate at 1.67% by December, suggesting potential additional easing actions.

According to data, euro zone economic sentiment improved in May. London trade saw the 10-year U.S. Treasury yield down by 5 basis points to 4.46%. Analysis points to possible regulatory relief favoring increased bond demand, potentially driving yields lower amidst rising deficit concerns. U.S. regulators are expected to revise the "supplementary leverage ratio", potentially reducing banks' required cash reserves and prompting greater engagement in Treasury markets. The U.S. Senate is set to debate a tax and spending bill that could increase national debt, prompting some senators to advocate for significant modifications.

(With inputs from agencies.)