Euro zone bond yields dip, market torn between COVID-19 caution and reflation

LONDON: Most euro zone bond yields dipped on Monday, with German yields holding below recent five-week highs, on expectations that monetary stimulus will remain in place for some time as the bloc grapples with a new variant of the coronavirus.

Borrowing costs in the euro area have risen at the start of the new year as last week's Senate runoff results in Georgia boosted expectations for more fiscal stimulus under President-elect Joe Biden, triggering a jump in US Treasury yields.

In the euro area, that upward pull on bond yields from the so-called reflation trade has met resistance as rising coronavirus cases and stringent restrictions weigh on economic growth prospects and boost expectations for European Central Bank stimulus to remain in place for longer.

JPMorgan analysts said bond markets remain caught in a tug of war.

"The expectation of further fiscal stimulus in the US following the run-off elections result in Georgia, the removal of tail risk with a Brexit deal and the seasonal supply dynamic put pressure to higher long-end yields and to steeper curves," they said in a note.

"However, increasing concerns about high infection rates and prolonged lockdown measures mostly across Western Europe combined with solid duration demand provide a lid on potential back up in rates."

Most 10-year bond yields in the euro zone's higher-rated economies were a touch lower on the day .

Germany's 10-year Bund yield was down 1 bps at -0.53% , off Friday's five-week highs at -0.51%.

"In Europe, there is scope for more upside in sovereign bonds (prices) just because we are seeing a resurgence of coronavirus cases and a tightening of the lockdown," said Saxo Bank fixed income strategist Althea Spinozzi.

Bond strategists said other key themes on the radar were supply, typically heavy at the start of the year. Commerzbank estimates new issuance in the bloc could top 20 billion euros this week.

Also in focus was Italy's 10-year bond yield spread over Germany. That gap tightened to around 99 bps on Friday, according to Refinitiv data, its narrowest since 2016. It was trading close to 104 bps on Monday, with some focus on political uncertainty in Italy.

Prime Minister Giuseppe Conte faces a showdown with his coalition partner and former premier Matteo Renzi this week that could bring down his government even as it struggles to contain COVID-19.

Italian President Sergio Mattarella has called on ruling parties to approve a European Union recovery plan before dealing with a looming political crisis, Italian newspapers reported on Monday.