Euro zone bond yields rise as markets eye Fed under Warsh

By Stefano Rebaudo and Lucy Raitano

Feb 3 (Reuters) - Euro zone government bond yields rose on Tuesday, taking the lead from U.S. Treasuries as markets assessed how Kevin Warsh, tapped to be the next Federal Reserve chair, could shape the Fed’s policy trajectory.

Warsh has called on the central bank to lower rates, citing stronger productivity growth from AI, and to reduce its balance sheet - a combination that analysts say points to a steeper yield curve.

Germany’s 10-year government bond yield DE10YT=RR, the euro area’s benchmark, rose 2.6 basis points (bps) to 2.89%. It reached 2.94% in March last year when Germany announced plans to massively increase fiscal spending.

U.S. Treasury yields rose with the 10-year up one 1 bp at 4.29%, after rising on Monday as traders considered Warsh’s potential impact on monetary policy.

"The market reaction in bond space to the nomination of Kevin Warsh looks rather muted compared to commodities or the dollar, but the direction of travel makes sense: steeper U.S. Treasury curve, higher real yields, lower inflation break-evens, wider long-end swap spreads," said Christoph Rieger, head of rates and credit research at Commerzbank.

The yield gap between 2-year and 30-year bonds in the U.S. US2US30=RR widened to 133.4 bps from 128 bps on January 28 before Trump said he intended to announce his pick to replace Fed Chair Jerome Powell, with speculation intensifying that the nod will go to Warsh. The German yield curve DE2DE30=RR also steepened.

German two-year government bond yields recorded in January their largest monthly drop since last April, driven lower by investors betting the European Central Bank will factor in the deflationary drag from a stronger euro as it considers monetary policy. The euro was at 1.18 against the greenback after hitting a five-year high at 1.20 last week.

The two-year yields DE2YT=RR were 1 bp higher at 2.1%.

Money markets priced in around a 200% chance of an ECB rate cut in September EURESTECBM6X7=ICAP, and indicated a 30% probability of a rate hike in April 2027. EURESTECBM11X12=ICAP

Morgan Stanley research analysts said in a Tuesday note they expect the ECB to remain on hold for now, as they think first-quarter 2026 inflation will come in below forecasts.

Euro zone banks tightened access to corporate credit last quarter and expect to see further tightening ahead due to widespread economic uncertainty, the ECB's quarterly Bank Lending Survey showed on Tuesday. Meanwhile, in France consumer prices rose less than expected in January.

France’s 10-year government bond yields FR10YT=RR were up 1.5 bps at 3.47%. The gap versus safe-haven Bunds was at 57.3 bps, after tightening to 53.50 in mid-January, its lowest level since August 2008.

Italy’s 10-year yields IT10YT=RR rose 2 bps to 3.51%. The spread versus Bunds was at 60 bps.