Global Market: Eurozone bond markets stabilise after volatile week

Eurozone government bonds stabilised on Friday after a volatile week, as investors weighed concerns over the finances of heavily indebted countries against a broader flight to safety driven by uncertainty surrounding artificial intelligence investments and global economic growth.

French government bond yields eased in early trading, falling 3 basis points to 5.06%, but remained on track for their biggest weekly increase since late May. French 10-year yields have risen nearly 28 basis points this week, the largest increase among euro zone countries, reflecting mounting concerns over the country's fiscal outlook.

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Belgian 10-year yields have climbed 17 basis points this week, while Italian yields have risen 10 basis points. In contrast, German and Dutch 10-year yields have declined by 7.4 basis points and 6 basis points, respectively, highlighting a growing divide between countries with weaker public finances and those viewed as safer borrowers.

German Bund yields were little changed at 3.342% on Friday, while Dutch yields edged up 1 basis point to 3.452%. The divergence has pushed the risk premiums on French and Belgian government debt to their highest levels in well over a decade.

The broader bond market has been supported by a sharp rally in safe-haven assets, particularly US Treasuries, after renewed concerns about the profitability of artificial intelligence investments and their implications for global growth.

US Treasury yields fell sharply overnight, with the 10-year yield dropping nearly 20 basis points in its biggest single-day decline since March 2023. Japanese government bond yields have fallen around 14 basis points this week, while US Treasury yields have declined by 12 basis points. British gilt yields have dropped 4 basis points over the same period.

The shift towards safer assets has overshadowed other developments that would ordinarily put pressure on government bonds. Crude oil futures have risen around 4% this week, moving above $110 a barrel following renewed Houthi attacks on Gulf infrastructure. Higher oil prices typically fuel inflation concerns and reduce the appeal of fixed-income securities.

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Investors are increasingly focused on whether companies developing and supplying artificial intelligence technology can generate sufficient returns on the trillions of dollars being committed to the sector. The resulting uncertainty has revived demand for government bonds as a portfolio hedge.

Central bank decisions in focus
Investors are also preparing for a series of major central bank decisions next week, with the US Federal Reserve, the Bank of Japan and the European Central Bank all expected to leave interest rates unchanged.

The ECB's policy outlook will be closely watched, particularly as rising French borrowing costs raise concerns about the potential for sovereign debt stress to spread across the region's financial markets.

According to Reuters, Deutsche Bank strategist Jim Reid noted that recent market stress had prompted fresh questions about the likelihood of further ECB rate increases this year.

Money markets had reduced the probability of an ECB rate hike by December to 69% on Thursday, down from 90% at Wednesday's close, reflecting growing doubts about the sustainability of further monetary tightening. However, LSEG data showed that the implied probability had recovered to around 80% by Friday morning.

Investors will therefore scrutinise ECB President Christine Lagarde's comments for clues about the bank's policy trajectory and its assessment of risks stemming from the French bond market.

The widening gap between French and German borrowing costs remains a key indicator of investor concerns about fiscal sustainability in the euro zone. While demand for safer government debt has helped stabilise broader bond markets, persistent pressure on France and other heavily indebted economies could keep sovereign risk firmly in focus in the coming weeks.

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times.)
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