Euro zone yields up as trade war fears recede, ECB rate cut bets lowered

By Stefano Rebaudo and Lucy Raitano

April 23 (Reuters) - Euro area government bond yields leapt to a six-day high on Wednesday after the Wall Street Journal reported the White House is mulling slashing China tariffs to between 50-65%.

German long-dated bond yields jumped about 5 basis points on the news in early afternoon trading, and were last up 6 bps at 2.503% DE10YT=RR.

Germany's 2-year yield DE2YT=RR, more sensitive to expectations for ECB policy rates, also jumped and was last up 8 bps to 1.743%. It hit 1.622% on Tuesday, the lowest since October 2022.

Traders have scaled back bets on European Central Bank rate cuts following the latest U.S. government moves which eased fears of a trade war with China.

U.S. Treasury Secretary Scott Bessent talked about a possible de-escalation in U.S.-China trade tensions, while President Donald Trump backed off from threats to fire the head of the Federal Reserve.

Money markets priced in an ECB deposit facility rate at 1.63% in December EURESTECBM5X6=ICAP, up from 1.55% late Tuesday and below the 1.72% shortly before last week's policy meeting.

"I'm baffled like most people on how the U.S. is walking back some of the tariff rhetoric. Euro bond yields are digging in on support levels and trying to stage a modest bounce but they are fragile," said Kenneth Broux, head of corporate research FX and rates at Societe Generale.

The Trump administration would look at lowering tariffs on imported Chinese goods pending talks with Beijing, a source familiar with the matter said on Wednesday, adding that any action would be in conjunction with negotiations and not made unilaterally.

"Trump appears to be backpedalling on the two battles he cannot win - China and Powell," said Mohit Kumar, chief economist Europe at Jefferies.

"It doesn't mean that we will not get further headlines from Trump blaming the Fed, but the market should be relieved that a near-term tail risk has been reduced," he added.

Markets have sold off U.S. assets in favour of the euro, driven by fears a U.S.-China trade war could plunge the economy into recession and concerns that Trump's criticism of the Fed could undermine the dollar's status as a reserve currency.

U.S. Treasury long-term yields fell. The 10-year yield US10YT=RR was down 2 bps at 4.38% after slipping on Tuesday as fears that Trump's trade policies could trigger a U.S. economic slowdown drove safe-haven demand.

"April's euro zone flash PMIs suggest that the immediate damage to production from U.S. trade policy has been limited so far," said Jack Allen-Reynolds, deputy chief euro zone economist at Capital Economics.

Euro area borrowing costs briefly ticked up after a batch of data earlier in the session showed euro zone business growth has stalled while contracting in Germany and France.

"This (the drop in the business outlook) highlights the risks to our forecast that growth in the euro zone can pick up substantially from the second half of the year onwards," said Salomon Fiedler, economist at Berenberg.

Wage growth is expected to ease considerably this year, ECB data showed.

The yield spread between French and German 10-year bonds DE10FR10=RR - the risk premium investors demand for holding French assets - was 77.1 bps, the mid-level of the trading range since early June, after Bloomberg News reported on Tuesday that French President Emmanuel Macron had floated the idea of snap elections.

"We retain our structural bearish bias on France with an expected trading range of 65-90 bps spread versus Bunds for French bonds," said Jefferies' Kumar, noting that elections are likely.