Bund yields set to end week flat after taking cues from US Treasuries

By Stefano Rebaudo

Jan 16 (Reuters) - Euro area benchmark Bund yields were set to end the week roughly unchanged, having tracked mixed movements in U.S. Treasuries through the week on conflicting signals about the U.S. economy.

Germany's 10-year yields DE10YT=RR were up 2 basis points at 2.838%, on track for a 1-bp weekly rise. Yields dropped 7.3 bps the previous week for the sharpest decline since late March.

The yield on the benchmark U.S. 10-year Treasury note US10YT=RR was up 3 bps at 4.19%. It rose on Thursday, after a round of economic data came in stronger than expected, having dipped on Wednesday on softer readings on consumer health and inflation.

INVESTORS' FOCUS SHIFTS TO FISCAL POLICY

The spread between U.S. Treasuries and Bunds DE10US10=RR was at 135 bps. It hit 122.86 in mid-December, the lowest since June 2023, as expectations grew that the Federal Reserve would cut interest rates further while the European Central Bank was forecast to hold rates steady throughout 2026.

With the European Central Bank expected to stay on hold through 2026, investors' focus has shifted to fiscal policy.

"Fiscal expansion in 2026 infers that the euro zone economy may continue to grow around 1%, with Southern Europe continuing to outperform on a relative basis within the region," said Mark Dowding, chief investment officer at RBC BlueBay Asset Management.

"The ECB is more likely to cut rates than hike in 2026, though no change in monetary policy is to be expected in the next couple of quarters, and we see Bund yields largely tracking sideways in this environment," he added.

German 2-year yields DE2YT=RR, more sensitive to expectations for policy rates, were up 0.5 bps at 2.11%.

Italy’s 10-year government bond yields IT10YT=RR rose 1.4 bps to 3.42%. Italy's 10-year spread over Bunds stood at 58 bps, after hitting 55 bps on Thursday — the tightest since August 2008. The country's fiscal discipline and robust risk appetite have boosted demand for Italian debt, which offers the euro zone's highest yield after France.

Sovereign bond markets have shrugged off geopolitical risks so far, to focus on economic fundamentals and the impact of German fiscal stimulus.

"There are early signs, particularly in the euro area, that the capex upswing is spreading beyond AI-related sectors," said Raphael Olszyna-Marzys, economist at J. Safra Sarasin Asset Management.