Euro zone yields reverse from earlier rise on renewed trade tensions

By Stefano Rebaudo and Linda Pasquini

May 19 (Reuters) - Euro zone government bond yields turned negative after tracking a rise in U.S. Treasuries earlier on Monday, with investors moving to safer assets over doubts about a trade-war truce between the U.S. and China.

Yields had risen earlier in the session on worries that a U.S. tax bill will increase the debt load by more than previously expected.

A Moody's downgrade of the U.S. credit rating had also added to concerns about future fiscal policies, helping longer-dated Treasury yields rise , with the 30-year yield hitting an 18-month high.

However, Germany's 10-year yield DE10YT=RR, the euro zone benchmark, fell by 1 basis point (bp) in afternoon trading to 2.576%, as China urged the United States to "immediately correct its wrongdoings" on curbs over exports of chips, dampening hopes about a pause in the trade war between the two countries.

"Headlines relating to China's upset over U.S. chip export controls look to be behind the recovery (in bond prices), with these shaking earlier confidence regarding a trade-war truce," said Richard McGuire, head of rates strategy at Rabobank.

Bund yields had risen to as high as 2.653% earlier in the session, not far from the 2.70% hit last week, the highest level since April 10.

U.S. Treasury yields also eased off earlier session highs, with the 10-year US10YT=RR up 6 bps at 4.50% after a 12-bps rise earlier, while stocks and the dollar retreated.

New York Federal Reserve President John Williams acknowledged on Monday that investors are taking a look at how they invest in U.S. assets while noting he's seen no large-scale move away.

Williams added that the U.S. central bank can take its time before deciding its next interest rate move.

Markets are still pricing in only nearly 53 basis points of Federal Reserve rate cuts this year, compared to more than 100 basis points a month ago.

Moody's Friday move on the U.S., which could complicate President Donald Trump's efforts to cut taxes, also drew investors' attention to expectations of growing public debt across the euro area.

Germany approved a massive fiscal stimulus to fund defence and infrastructure spending, while markets expect some form of debt mutualisation at the European Union level for other countries' military investments.

The ECB may need to cut interest rates to "slightly below" 2% as the euro zone might be exposed to an adverse tariff-induced economic shock in the short term followed by a positive shock in 2026 and 2027, Belgian central bank governor Pierre Wunsch told the Financial Times in a weekend interview.

Money markets priced in a European Central Bank deposit facility rate of 1.73% by year-end EURESTECBM5X6=ICAP, roughly unchanged from late Friday.

U.S. President Donald Trump's sweeping tax-cut bill won approval from a key congressional committee on Sunday. The measure would extend Trump's 2017 tax cuts, boost defence spending and provide more funds for his immigration crackdown.

Analysts said the tax bill talks would translate into upward pressure on U.S. Treasury yields.

Mark Haefele, chief investment officer at UBS Global Wealth Management, flagged that most investment mandates do not require AAA ratings for U.S. Treasuries, and central banks continue to value the Treasury market for its exceptionally deep liquidity.

"We would also expect the Federal Reserve to step in if there were a disorderly or unsustainable increase in bond yields," he argued.

German two-year yields DE2YT=RR, more sensitive to ECB policy rates, were down 1.5 bps to 1.84%.

Italy's 10-year yield slid 1 bp to 3.596% IT10YT=RR. The spread between Italian and German yields – a market gauge of the risk premium investors demand to hold Italian debt – was at 99.7 bps DE10IT10=RR, after narrowing to its tightest since April 2021 at around 94 bps last week.