Euro area government bonds react cautiously to Trump announcements

Updates in European afternoon trade

By Stefano Rebaudo

Jan 21 (Reuters) - Euro zone government bonds edged down 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.

Trump, however, told reporters he was thinking about implementing tariffs of around 25% on imports from Canada and Mexico at the start of February.

With Trump back in the White House, uncertainty about U.S. policy will remain high, and so will market volatility. However, most analysts are still confident that the U.S. economy will remain strong and that 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 about 2 basis points (bp) at 2.475%, after hitting 2.47%, its lowest since Jan. 8.

U.S. Treasury yields dropped, with the 10-year 5 bps lower at 4.56%. US10YT=RR

The lack of concrete tariff measures prompted the dollar to weaken on Monday, though it pared some losses after Trump said he was mulling 25% tariffs on Canada and Mexico.

'TRUMP SENSITIVITY'

"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 15 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 (ECB) rate expectations, was down 1.5 bps at 2.205%.

Easing tariff fears cemented bets on a rate cut from the ECB next week, with traders pricing in a 25 bps cut at the central bank's Jan. 30 meeting.

Money markets priced in an ECB deposit facility rate at about 2% at the end of 2025 EURESTECBM8X9=ICAP, from the current 3%.

Italy's 10-year yield IT10YT=RR was 2.5 bps lower at 3.591%. The gap between Italian and German yields DE10IT10=RR - a gauge of the risk premium investors demand to hold Italian debt - stood at 110.9 bps. It hit 104.5 bps in early December, its tightest since October 2021.

(Reporting by Stefano Rebaudo and Greta Rosen Fondahn, editing by David Evans and Gareth Jones)

((stefano.rebaudo@tr.com))