Euro zone yields edge up, ultra-long end of German curve steepens

By Stefano Rebaudo

Dec 1 (Reuters) - Germany's short-dated borrowing costs hit an eight-month high on Monday, while the ultra-long end of the German yield curve hovered around its steepest since May 2019.

This move of the curve signals that investors are pricing in greater uncertainty around long-term bond supply in Germany.

Nevertheless, German Bunds are still expected to retain their status as the euro area's safest asset in the coming years, despite the sharp increase in fiscal spending.

Germany's parliament on Friday passed the 2026 budget with over 180 billion euros ($209 billion) in new debt, outlining how Berlin will use its financial firepower to revive the anaemic economy.

MARKETS PRICE IN 25% CHANCE OF A RATE CUT IN 2026

Money markets priced in a roughly 25% chance of an ECB rate cut by September EURESTECBM7X8=ICAP and a key rate at 1.95% in December 2026. The ECB depo rate is currently 2%.

Most analysts' base case scenario involves an ECB rate on hold in 2026, but risks remained skewed towards another rate cut if inflation should drop significantly below target.

“The sizeable fiscal stimulus in support of defence and infrastructure (in the European Union and Germany) should become increasingly visible from early 2026,” said Reinhard Cluse, chief European economist at UBS.

“That said, we still see the forecast risk as skewed towards another rate cut for the coming six months,” he added.

Germany’s 10-year yields DE10YT=RR, the euro area’s benchmark, was up 2.5 basis points (bps) to 2.71%.

The 2-year yields DE2YT=RR, more sensitive to expectations for policy rates, hit 2.063%, the highest since March 27, and were last up 2 bps at 2.05%.

GAP BETWEEN 30-YEAR, 10-YEAR YIELDS HIGHEST SINCE MAY 2019

Germany’s gap between 30-year and 10-year yields DE10DE30=RR was at 63.50 bps after hitting the highest since May 2019 at 64.40 bps in late November.

Meanwhile, the spread between 10-year and 2-year Bund yields DE2DE10=RR — anchored by Bunds’ safe-haven status — was at 67 bps, far below its multi-year peak of 90 basis points hit in early April.

Investors awaited euro area inflation data due on Tuesday, even if single country figures released last week already reinforced economists' bets that no further ECB rate cuts are coming in the near future.

Benchmark 10-year U.S. Treasuries yields US10YT=RR were up 2 bps at 4.04% after rising on Friday amid low volumes after the U.S. Thanksgiving holiday.

The yield spread between U.S. and German 10-year borrowing costs DE10US10=RR was at 132.50 bps after hitting 131.96 bps last week, its lowest level since April 7.

U.S. Treasuries costs remain in the driving seat, while euro area volatility is expected to stay muted as the ECB is seen holding rates into 2027.

The yield gap between Italian and German bonds - a market indicator of the extra yield investors demand to hold Italian debt instead of safe-haven Bunds - hit a 16-year low at 68.80 bps.

Economic resilience and fiscal discipline in so-called peripheral countries, coupled with Germany’s sluggish growth and rising bond issuance, have steadily narrowed yield spreads over Bunds to multi-year lows.

($1 = 0.8598 euros)