European bond yields remained stable on Wednesday as investors sought the safety of government bonds amidst nervous market sentiment. Germany’s 10-year Bund yield fell marginally to 2.44%, following a significant drop of nearly 12 basis points in the previous session. The two-year yield remained flat at 3.09%, reaching a two-month low after experiencing a 6.5 basis point decline the day before.
The larger slump in the 10-year yield compared to the two-year caused the German yield curve to invert further, prompting bond investors to anticipate a return to a more normal shape for yield curves. Analysts at DZ bank noted that risk aversion dominated the trading session, with the beneficiary of safe-haven flows being the European Monetary Union (EMU) government bond segment. As a result, ten-year Bund yields experienced double-digit declines, while Bund spreads on other EMU debt remained stable.
The widely-watched spread between German and Italian 10-year yields remained unchanged at 166.9 basis points. Risk aversion was driven, in part, by Moody’s downgrade of ten U.S. regional banks and Italy’s unexpected imposition of a one-off windfall tax on domestic lenders, which unsettled equity markets.
To alleviate concerns, the Italian Treasury announced that the tax proceeds would not exceed 0.1% of lenders’ total assets. Consequently, Italian banking stocks rebounded, recovering some of the losses from the previous day. Italy’s 10-year yield dropped around 2 basis points to a one-week low of 4.11%, while the two-year yield also saw a similar decline to 3.62%, just above the near two-month low reached the previous day.
For the remainder of Wednesday, the market is bracing for the release of U.S. Consumer Price Index (CPI) figures, which are considered the main event of the week. The data will play a crucial role in either reinforcing or disrupting market expectations regarding the Federal Reserve’s stance on interest rate hikes.
Earlier in the day, China’s consumer sector experienced deflation, while factory-gate prices continued to decline in July. These indications that the world’s second-largest economy is struggling to revive demand added to the prevailing cautious sentiment.
In summary, European bond yields remained steady as investors sought refuge in government bonds amid a climate of risk aversion. While Germany’s Bund yields saw a modest decrease, Italian banking stocks recovered ground after the announcement that the windfall tax would have limited impact. Eyes are now turning to the upcoming U.S. CPI figures for further market direction.
