Euro zone yields fall as investors cut bets on ECB hikes

Euro zone government bond yields edged lower on Tuesday, stabilising after a late rally a day earlier as investors pared bets on further European Central Bank rate rises, even as expectations grew that the Federal Reserve would keep hiking.

German 2-year bonds rallied sharply in late trade on Monday, which sent yields down by the most in two weeks, after ECB President Christine Lagarde told the European Parliament there was no evidence of the kind of pickup in inflation that would warrant more forceful policy action.

Schatz yields fell nearly 5 basis points on the day to 2.595% on Monday, compared with 2-year U.S. Treasury yields US2YT=RR, which shot up 5 bps to 4.236%, the highest in 16 months, as traders ramped up their bets on the Fed raising interest rates in the months to come.

On Tuesday morning in Europe, 2-year German yields were down 1 bp on the day at 2.578% in early trading, compared with 4.198% for their U.S. counterparts.

This has brought the discount the German government pays to borrow for two years to that paid by the U.S. to around 163 basis points, the largest since September 2025, and much wider than the about 113-bps gap two months ago.

A steady stream of robust U.S. economic data and a shift in rhetoric from the Fed under new Chair Kevin Warsh to focus more on containing inflation have dented demand for Treasuries and pushed up the dollar in the last week or so.

With the oil price now below $80 a barrel and falling, thanks to flows of crude and products ramping up through the Strait of Hormuz, expectations for the ECB to raise rates aggressively to anchor inflation have receded.

Meanwhile, money markets showed traders believe euro zone rates will end this year around 31 basis points higher than where they are now, with the next hike coming in October. Before Lagarde spoke on Monday, around 35 bps were priced in.

"We would read the comments as suggesting that no more hikes are required, if oil prices were to stay at similar or lower levels. That has been our view since the last ECB meeting that the ECB would not need to hike anymore in this business cycle," Jefferies strategist Mohit Kumar said.

Benchmark 10-year Bund yields DE10YT=RR were down 2 bps on the day at 2.934%, while Italian 10-year debt IT10YT=RR was yielding 3.651%, also down 2 bps.

One-year euro zone inflation swaps EUCPIZ1Y=TWEB have collapsed to around 2.52% this week, which is still above the ECB's 2% rate, but well beneath late May's three-year peak of nearly 4%.

-Reporting by Amanda Cooper; Editing by Jamie Freed/Reuters