Bund yields hit fresh one-month low, French government collapse priced in

By Stefano Rebaudo

Sept 8 (Reuters) - Euro area benchmark Bund yields dropped to a fresh one-month low on Monday, extending last week’s slide when soft U.S. data reinforced expectations for Federal Reserve rate cuts.

Investors are awaiting a confidence vote in the French Parliament, though markets expect only a muted reaction to the likely collapse of the government.

Germany’s 10-year bond yield DE10YT=RR, the benchmark for the euro zone bloc, fell 2 basis points (bps) to 2.6405%, its lowest level since August 8.

Investor morale in the euro area plunged in September to its lowest since April, with Germany posting a sharper decline.

The benchmark 10-year U.S. Treasury yield US10YT=RR dropped 3.5 bps to 4.05%, with investors cautious before the release of U.S. inflation data later this week.

The yield gap between safe-haven German Bunds and 10-year French government bonds (OATs) DE10FR10=RR — a market gauge of the risk premium investors demand to hold French debt — tightened to 76 bps after reaching 82 bps last week.

"OATs are largely priced for the collapse of the Bayrou government at the confidence vote today and a compromise deal avoiding a snap election," Citi said.

President Emanuel Macron has so far resisted the idea of renewed snap elections and would therefore be required to appoint a new prime minister.

In case of snap elections the yield gap between OATs and Bunds would widen towards 90 bps, according to Citi.

Markets await the European Central Bank's policy meeting later this week, with investors anticipating no rate cuts and a deliberately vague message on the future monetary path.

Markets priced in an 80% chance of a 25 bps ECB cut by next summer EURESTECBM8X9=ICAP to 1.75%.

“The most likely driver of an additional rate cut would be some kind of stress or disorderly moves in long-term bond yields, possibly led by the U.S,” said Simon Wells, chief European economist at HSBC.

“But it could also be domestic, fiscal, related to French politics, or something along those lines,” he added.

While Macron is expected to appoint a head of government, analysts questioned how long a new nominee might last.

Yields on 30-year German government bonds DE30YT=RR fell 3.5 bps to 3.27%. They reached 3.434% early last week, their highest since summer 2011.

Ultra-long borrowing costs rose as investors expected Germany’s investment plans, along with likely increases in defence spending across euro area countries, to push up debt.

France’s 30-year government bond yield FR30YT=RR was down 5 bps at 4.321%, its lowest level since August 22. It hit 4.523% last week, its highest since June 2009.

Germany’s 2-year yields DE2YT=RR, more sensitive to expectations for ECB policy rates, were down 0.5 bps at 1.92%.