German yield spread tightest since 2017 as US curve flattens

LONDON: The gap between Germany's two-year and 10-year bond yields tightened to its narrowest in 17 months on Tuesday, after parts of the U.S. Treasury yield curve inverted overnight as optimism over the U.S.-China trade agreement faded.

Relief over a pause in the trade war between the U.S. and China has given way to doubts over whether the two countries can resolve their differences.

The drop in the two-to-10-year U.S. Treasury yield curve to its flattest in more than a decade - at 12 basis points on Tuesday - was a reminder of the future economic slowdown and recession fears regardless of a breakthrough on trade.

Yields on short-dated U.S. Treasury notes rose above five-year borrowing costs on Monday for the first time in more than a decade.

"The number one driver for global risk sentiment is the U.S.-China trade talks, which suddenly don't look as promising as they did over the weekend," Commerzbank strategist Christoph Rieger said.

"What sounds good at the dinner table becomes rather difficult at the negotiating table - the market now knows how to read Trump, he knows how to create big news at bilateral meetings but then when it comes to the nitty gritty it can be a very different story," he said.

The gap between two-year and 10-year German bond yields tightened to 86 basis points, after the spread between two-year and 10-year U.S. Treasury yields narrowed overnight.

Bob Michele, who heads global fixed income for JP Morgan's investment arm, said he doesn't expect the U.S. yield curve to invert, but he was watching it closely.

Germany's 10-year bond yield fell to its lowest in four and a half months at 0.265 percent and was last down 4 bps on the day.

German 10-year yields are also being pushed down by domestic concerns, Commerzbank's Rieger said, with European growth indicators sagging and Italian political concerns rumbling on in the background.

Data on Monday showed euro zone manufacturing expanded at its weakest rate in over two years in November, more evidence that the bloc's economic growth is past its peak.

Meanwhile, Italian Prime Minister Giuseppe Conte will present a new budget proposal in the next few hours, he told the newspaper Avvenire, aiming to avoid a disciplinary procedure by Brussels.

Italian bond yields have dropped in recent days on hopes that Italy will reach a compromise with the EU on its budget.

They hovered close to two-month lows on Tuesday.