Euro area government bonds show cautious reaction to Trump announcements

By Stefano Rebaudo

Jan 21 (Reuters) - Euro zone government bonds were mixed on Tuesday, showing a relatively muted reaction to U.S. President Donald Trump's announcement that he wouldn't immediately impose new tariffs, which left investors in a wait-and-see mode about U.S. policies.

Markets had been expecting Trump to announce trade tariffs via executive orders, raising the prospects of higher inflation and higher-for-longer Federal Reserve policy rates.

With Trump as U.S. President, uncertainty about U.S. policy will remain high, and so will be market volatility. However, most analysts are still confident that the U.S. economy will remain strong and inflation will subside.

"The President may 'escalate to deescalate,' with some of his proposals likely to prove to be negotiating tactics," said Mark Haefele, chief investment officer at UBS Wealth Management.

"Financial and political constraints are likely to mean that enacted policy risks falling short of campaign pledges in some instances," he added, arguing that where the U.S. President enjoys more leeway is in the use of executive orders to impose tariffs on imports.

Trump also pledged to cut taxes, return illegal immigrants to their home countries, and increase oil production.

Germany's 10-year bond yield DE10YT=RR, the benchmark for the euro zone bloc, was down 0.5 basis points (bps) at 2.49%, after hitting 2.472%, its lowest since Jan. 8.

U.S. Treasury yields dropped, with the 10-year 4.5 bps lower at 4.57% US10YT=RR in London trade.

The lack of concrete tariff measures made investors more dovish on the U.S. rate outlook.

"The greatest Trump sensitivity in financial markets is on trade policy, which has a significant direct impact on the dollar and equities, and indirectly on bonds," said Christoph Rieger, head of rates and credit research at Commerzbank.

"It is positive for U.S. Treasuries by easing inflation fears, while the impact on Bunds is more mixed, especially if China trade deflation expectations are priced out," he added.

Bund yields fell around 14 bps after hitting 2.63% on Jan. 15, the highest level since June 2024. However, the bulk of the recent drop was due to U.S. inflation data that day, with yields falling 9.5 bps. It lost less than 3 bps after leaks and statements about Trump's future policy.

Germany's two-year yield DE2YT=RR, more sensitive to European Central Bank rate expectations, was flat at 2.22%.

Money markets priced in a European Central Bank deposit facility rate at 2% at the end of 2025 EURESTECBM8X9=ICAP, from the current 3%.

Italy's 10-year yield IT10YT=RR was one bp lower at 3.604%. The gap between Italian and German yields DE10IT10=RR - a gauge of the risk premium investors demand to hold Italian debt - rose to 112 bps. It hit 104.5 bps in early December, its tightest since October 2021.

(Reporting by Stefano Rebaudo, editing by David Evans)

((stefano.rebaudo@tr.com))