The narrowing of the yield gap between Italian and German bonds to its lowest level since March 2022 reflects a mixed sentiment in Eurozone borrowing costs. Investors are showing interest in Italian bonds, attracted by their relatively higher returns compared to other Eurozone counterparts, amidst expectations of potential policy rate cuts.
The decreasing spread between Italian and German 10-year government bond yields, indicating reduced risk premium for highly indebted countries, is attributed to heightened risk appetite among investors. While the correlation between Italian BTP and German Bund yields has strengthened recently, signaling a diminished impact from Italy-specific factors, bonds from highly indebted nations continue to benefit from expectations of monetary easing and gradual reductions in the Pandemic Emergency Purchase Programme (PEPP) reinvestments.
Despite a flat performance of the Eurozone benchmark Bund yield, influenced by scaled-back expectations of future rate hikes, traders anticipate a subdued session with U.S. markets closed for Presidents’ Day. Attention will be on forthcoming data releases, including negotiated wage data, European Central Bank (ECB) policy meeting accounts, and Purchasing Managers’ Index (PMI) data later in the week.
The reduction in expectations for ECB rate cuts reflects strong economic data and cautious remarks from central bank officials on both sides of the Atlantic regarding monetary policy easing. While the pricing out of rate cuts may have reached a certain extent, there is no clear catalyst driving the narrative in the opposite direction.
The plunge in U.S. Treasuries on Friday, following economic data that tempered expectations for a Federal Reserve rate cut this year, had a corresponding impact on Eurozone bonds, as bond prices move inversely with yields.
