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Safe-haven German bond yields jump as risk aversion fades

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03/06/2018 | 06:06pm CEST
FILE PHOTO:Illustration photo of U.S. Dollar and Euro notes

LONDON (Reuters) - German bond yields rose sharply on Tuesday and were set for their worst day in a month as fears of a global trade war ebbed, lifting risk appetite and taking the shine off safe-haven assets before this week's European Central Bank meeting.

Italy's government bonds recovered from a selloff on Monday that was driven by a surge in support for anti-establishment parties in Sunday's inconclusive national election.

Germany's 10-year bond yield climbed over 6 basis points to 0.70 percent <DE10YT=RR> at one stage, before settling at 0.67 percent. It was still up 7.5 bps from around five-week lows hit on Monday following Italy's election.

Investor worries about an imminent trade war eased as U.S. President Donald Trump faced pressure from political allies to pull back from proposed steel and aluminium tariffs. That boosted stocks in Europe by 0.6 percent <.STOXX> and dented demand for fixed income.

To view a graphic on the worst day for Bund yields in five weeks, click: http://reut.rs/2D1K7kd

Risk appetite also got a boost from news that North Korea is willing to hold talks with the United States on denuclearisation and will suspend nuclear tests while those talks are under way, according to the South.

"Coming out of the weekend we had concerns about the Italian election, trade wars, and now all that is unwinding with stocks rallying," said Commerzbank rates strategist Rainer Guntermann. "That's why bonds are selling off."

Analysts said investors also appeared to look beyond immediate political risks in Italy, which has a history of post-election uncertainty.

"Investors are balancing the negative unknown, a negative outcome from the elections, against two positive knowns - a cyclical economic upswing and Sunday's ballot result in Germany which paves the way for a new government there," said Richard McGuire, head of rates strategy at Rabobank.

Italy's 10-year bond yield was steady at around 2.08 percent <IT10YT=RR>, while the premium investors demand to hold 10-year Italian debt over its benchmark German equivalent briefly fell to its lowest level in two weeks at around 137 bps.

NEXT UP...

As investors awaited further news on the make-up of Italy's next government, Thursday's European Central Bank meeting shifted into focus.

Policymakers are likely to discuss dropping their easing bias - a stipulation that asset buys could be increased if necessary - but a broader revision of the bank's policy guidance is likely to happen later, possibly during the summer, sources told Reuters last week.

A strong economy means the ECB is widely expected to end its 2.55 trillion euro stimulus scheme by year-end, confident that inflation will at some point rise slowly.

A key market gauge of long-term expectations on Monday dipped below 1.70 percent to its lowest level this year <EUIL5YF5Y=R>.

"The ECB is going to be presenting growth forecasts that are likely to be stronger, but will be at pains to stress that the move away from monetary easing will be delicately done and slowly," said Peter Chatwell, head of euro rates strategy at Mizuho.

(Reporting by Dhara Ranasinghe; Additional reporting by Fanny Potkin; editing by John Stonestreet and Susan Fenton)

By Dhara Ranasinghe

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