Economic Uncertainty: Euro Zone Bond Yields Plunge Amid U.S. Trade Policy Impact

Euro zone benchmark Bund yields are poised for their most significant weekly decline since mid-April as investors pivot toward the long-term negative economic implications of U.S. trade policy.

Borrowing costs dropped on Thursday due to risks of continued policy and economic stagnation. Meanwhile, Germany's 10-year government bond yield, the euro zone benchmark, rose by 2 basis points to 2.53%, following a three-week low at 2.497%, anticipating a 4.5 basis point weekly decrease.

On Thursday, a U.S. appeals court re-enforced U.S. President Donald Trump's tariffs, leaving Wall Street without a clear trajectory after a trade court previously blocked most tariffs. Friday's market showed minimal reaction to varied inflation figures from German states, with national statistics forthcoming at 1200 GMT.

The latest European Central Bank data released on Friday reveals euro zone bank lending rebounded last month, likely due to lower interest rates. Investors are now awaiting U.S. Personal Consumption Expenditures (PCE) price index data, a favored inflation measure by the Federal Reserve, set to be released later today.

Michiel Tukker, ING's senior European rates strategist, commented, "U.S. data may exert more influence on euro rates than domestic data due to potential impacts on global risk sentiment which can bull flatten the euro curve." He noted that with 10-year Bunds aligning with swap levels, markets are bracing for more challenges and uncertain futures.

The interest rate differential between swaps and Bund yields stood at minus 2.5 basis points on Friday, having hit a record low of around -16 basis points in March. It previously hovered around 25 basis points in October 2024 before a German political crisis occurred.

The benchmark 10-year U.S. Treasury yield remained stable at 4.42%, following a Thursday dip attributed to soft economic data and concerns over sustained trade policy uncertainty.

Current market sentiment prices a 90% probability of a European Central Bank 25 basis point rate cut next week. Projections indicate a deposit facility rate of 1.70% by December, suggesting two rate reductions with a 20% likelihood of a third easing move. The ECB is expected to cut interest rates on June 5, with a strong majority of economists suggesting policymakers might pause by July as the economy grapples with threats from a U.S.-led trade conflict.

Italy's 10-year yield experienced a 2 basis point increase to 3.52%, after declining to 3.488%, a three-month low. This set a trajectory for the most substantial weekly drop by 8.5 basis points since mid-April. The spread between Italian and German yields was marked at 96 basis points, previously reaching its lowest since February 2021 at 89.80 basis points on Thursday.

(With inputs from agencies.)