Long-dated euro zone yields little changed, short-end yields drop on ECB cut bets

By Samuel Indyk

LONDON, April 9 (Reuters) - Longer-dated German bonds were little changed on Wednesday, after earlier being dragged lower by a sell-off in U.S. Treasuries in a sign that investors were differentiating between safe assets following the tariff-induced market rout.

Shorter-dated bonds, which are more sensitive to changes in interest rate expectations, were higher as investors added to bets that the European Central Bank will cut interest rates this year.

On Wednesday, U.S. President Donald Trump's "reciprocal" tariffs on dozens of countries took effect, including 104% duties on Chinese goods, deepening his global trade war.

China on Wednesday said it did not want a trade war with the U.S. but reiterated it will take the fight to the world's largest economy if Trump continues to ramp up trade tensions.

Germany's 10-year yield DE10YT=RR, the benchmark for the euro area, was last down 1 basis point (bp) at 2.62%, having earlier been higher by over 6 bps at 2.675%. Bond yields move inversely with prices.

In contrast, the benchmark 10-year U.S. Treasury yield US10YT=RR was up 12.5 bps at 4.3879%, having earlier risen as high as 4.515%. The 10-year yield has risen over 40 basis points from its low earlier this week.

That pushed the spread between German and U.S. 10-year yields wider to around 177 bps. DE10US10=RR

"It doesn't make sense to look at yields in the euro area in the same way as yields in the U.S.," said Anders Svendsen, chief analyst at Nordea.

"In Europe at least, bunds are becoming the safe asset again and Treasuries are becoming less of that."

Initially, perceived safe assets such as U.S. Treasuries were supported despite the market turmoil, but markets have sold these in recent days in an apparent dash for cash.

"There are signs that the credibility and reliability of the U.S. as a currency or trade partner is being put under pressure and that translates into people selling Treasuries," said Philippe Ferreira, deputy head of economics & cross-asset strategy at Kepler Cheuvreux.

One of those signs was a poorly-received three-year note auction from the U.S. Treasury on Tuesday. Another test for the U.S. bond market comes later on Wednesday when the Treasury is set to sell 10-year notes.

Others noted that hedge funds were at the heart of the selling in U.S. Treasuries, which had borrowed to bet on usually small gaps between cash and futures prices, the so-called "basis trade".

"In case of an exogenous shock, the highly leveraged long positions in cash Treasury securities by hedge funds are at risk of being rapidly unwound," said Torsten Slok, chief economist at Apollo Global Management, who estimated that the basis trade is worth around $800 billion.

MORE RATE CUTS?

Shorter-dated yields have fallen as markets bet that global central banks will lower interest rates at a faster pace in the face of slowing growth in the wake of tariffs.

The ECB was bracing for a bigger-than-anticipated growth hit from U.S. tariffs, four sources told Reuters.

Comments from ECB policymakers have been mixed in their response to Trump's tariff plan.

On Tuesday, Joachim Nagel said monetary policy will "do its part" as global growth prospects have deteriorated massively, while Olli Rehn said the trade war provides a stronger case for a rate cut this month.

Yet others have highlighted the probable inflationary impact of tariffs and the impact that may have on policy setting.

"Any further resurgence in inflation or inflation expectations could delay or even halt the process of monetary policy normalization," Greece's central bank Governor Yannis Stournaras said on Tuesday.

Dutch policymaker Klaas Knot said the tariffs imposed would likely have a stagflationary impact, driving up inflation while the economy stalls.

"With everything going on now, it makes sense for the ECB to cut by 25 basis points in April," said Nordea's Svendsen.

"If things completely blow up, there's a risk that they will do more but I think that's a low probability event here."

Money market traders have moved to fully price in a quarter-point interest rate cut from the ECB at its April meeting EURESTECBM1X2=ICAP, having only priced around an 85% chance on Tuesday.

Germany's monetary policy-sensitive two-year yield DE2YT=RR was down 9 bps at 1.777%.