LONDON: Euro zone bond yields fell back on Wednesday as the market euphoria from China's rate cut ebbed and investors feared more stimulus may be needed to halt a slowdown in the world's second largest economy.
Yields on Europe's top-rated German debt reversed half of a 15 basis point surge seen after Tuesday's intervention by China, while world stocks failed to build on a temporary boost.
The disappointing reaction in Chinese markets led to calls for further rate cuts in the months ahead, which will only weaken the yuan and export disinflation to the rest of the world.
More importantly for global investors though, China's malaise may prevent the United States, the world's largest economy and key trade partner, from raising interest rates for the first time in nearly a decade.
"If China is unable to prevent a continued rapid slowdown, the implications will be felt around the world," said Clare Howarth of Oxford Economics.
"Our scenario modelling indicates that a hard landing would prompt the Fed to delay raising rates, possibly for many months, with other monetary authorities following suit."
German 10-year yields -- the euro zone benchmark -- dropped 7 bps to 0.68 percent, but are still far from three-month lows of 0.51 percent hit on Monday when a slump in Chinese stocks sent investors scrambling for safety.
Lower-rated euro zone equivalents from the likes of Portugal, Spain and Italy were also down by 2-5 bps at 2.69 percent, 2.09 percent and 1.96 percent.
Many analysts said China's actions -- it lowered its one-year benchmark bank lending rate by 25 basis points to 4.6 percent and reduced the reserve requirement ratio by 50 basis points to 18.0 percent for most big banks -- will not be enough to shore up the slowdown in the economy.
In fact some banks are calling for one or two more rate cuts in the months ahead.
Oil markets, which have been shaken by weakening consumption and a supply gut, failed to take much of a boost from China's intervention, with prices remaining just above 6-1/2-year lows.
This has had a knock-on effect on the market's expectations for inflation around the world. Investors are still betting the euro zone, for instance, will head back into deflation in a year's time which will only up the pressure on the European Central Bank to expand its bond-buying programme.
"Important links are likely to stem from potential disinflationary trends - both through exchange rate appreciation, but perhaps more importantly through the reduction in demand for commodities from emerging markets," said RBC in a note to clients. "In this respect, the market measure of medium-term inflation expectations is worth keeping a close eye on."
Germany, the euro zone's powerhouse economy, will release preliminary inflation data for August on Friday.
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