German 2yr bond yield sees biggest drop since 2005 as PMIs fuel recession fears

FRANKFURT: German two-year bond yields were set for their biggest daily fall since 2005 on Friday as data showing business activity in the bloc unexpectedly contracted this month pushed traders to reprice their interest rate expectations.

Overall activity in the euro zone shrank due to an accelerating downturn in manufacturing and a near-stalling of service sector growth, with inflation pushing consumers to cut back spending, S&P Global’s Composite Purchasing Managers’ Index, a good gauge of economic health, showed.

Germany’s two-year yield, sensitive to interest rate expectations, dropped as low as 0.355% and was down over 26 bps to 0.399% by 1530 GMT, set for its biggest daily fall since January 2005 as markets reduced their bets on European Central Bank rate hikes this year.

Traders now price in 105 bps of ECB rate hikes by December, down from around 120 bps before the data, according to Refinitiv data. They price in an 80% chance of a 50 basis-point rate hike in September, down from a full probability on Thursday.

“I think it’s pretty clear that the market is growing increasingly worried about a eurozone recession this winter - activity is already falling off a cliff, and that’s before any potential Russian gas cut-off into the winter. The big bid into bonds is no surprise”, Michael Brown, head of market intelligence at Caxton, said. Germany’s 10-year bond yield, the benchmark for the euro area, fell below 1% for the first time since May 30, and was last down 19 bps. Bond yields move inversely to prices.