LONDON: German 10-year yields fell back below 1 percent on Tuesday as data showed investor morale hit its lowest in nearly two years in September, suggesting tensions between Russia and the West had hit Europe's largest economy.
Adding to the grim growth outlook, the OECD on Monday revised downward its global growth forecasts for major developed economies, including the euro zone, and urged more aggressive European Central Bank stimulus to ward off deflation in the currency bloc.
Price moves in the bond market were, however, modest, with investors cautious before the U.S. Federal Reserve's policy decision on Wednesday and Scotland's independence referendum on Thursday. The vote may have ripple effects on separatist movements elsewhere in Europe, particularly in Spain.
Against that backdrop, the market impact of the German ZEW survey, which showed economic sentiment dropping for a ninth straight month in September, could be fleeting.
"The ZEW and the OECD lowering the GDP growth expectations for the euro zone as a whole is probably why we have this slight bullish bias in German bonds," said Cyril Regnat, a fixed income strategist at Natixis.
"The mood surrounding the euro zone recovery is far less optimistic than it was during the first half of this year so the market is maybe expecting more from the ECB."
German 10-year yields, the benchmark for euro zone borrowing costs, fell 3 basis points to 0.992 percent.
They rose back above 1 percent last week as speculation that the Fed could raise interest rates sooner and faster than previously expected rattled financial markets across the globe.
Yields on other top-rated euro zone bonds also dipped in modest volumes as investors kept a wary eye on the start of the Fed's Open Market Committee policy meeting later on Tuesday.
SCOTS, FED EYED
Investors will be scanning the outcome on Wednesday for clues on the timing of the first U.S. rate hike in more than eight years. The market does not expect the Fed to raise rates until 2015, but recently strong U.S. economic data has led central bank officials to acknowledge they may need to act sooner than they thought just a few months ago.
The outlook on the Fed contrasts with the ECB's ultra-loose monetary policy stance in the face of ultra-low inflation and a stuttering recovery in the currency bloc.
The ECB surprised markets by cutting interest rates a week ago and unveiled plans to buy asset-backed securities and covered bonds, but stopped short of a full-fledged money printing scheme that would include buying sovereign bonds.
Some in the market doubt the latest measures are enough to fend off deflation and stimulate growth threatened by tit-for-tat sanctions between the West and Russia over violence in Ukraine. They expect the central bank eventually to embark on money printing, known as quantitative easing.
Peripheral euro zone bonds underperformed their lower-yielding peers, with Spanish 10-year yields 2.3 bps higher at 2.37 percent.
The yields have bounced off record lows just above 2 percent, hit after the ECB cut, as some investors worry the Scottish vote will embolden separatists in wealthy Catalonia.
"Spreads have been widening for a few days now. Initially it was driven by a bit of supply, but also the Scottish vote and what that means for Catalonia," said Myles Bradshaw, Pimco's European strategist and portfolio manager.
"What you are seeing is investors just taking some profits and that has caused Spanish spreads to widen, and a repricing of the periphery more broadly."
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