Europe’s government bonds surged and the euro weakened after fresh warning signs over the health of the region’s economy, just days before the central bank is expected to deliver another interest-rate hike.
German benchmark yields dropped at least seven basis points after data showed a decline in euro-area manufacturing and services gauges. That also drove down the common currency by as much as 0.5% to $1.1066, its lowest since July 12.
Treasuries followed the advance ahead of preliminary US PMIs for July. The 10-year yield slipped 4 basis points to 3.79%.
In Europe, the poor economic data is fanning doubts over how much further the central bank can keep hiking interest rates. While policy makers are still expected to deliver a quarter-point increase this week, taking the key rate to 3.75%, traders are now betting it won’t go past 4% and will then cut next year.
“We are not long schatz for nothing,” said Benoit Gerard, rates strategist at Natixis, referring to the two-year German bond, among the most sensitive to rate policy. Market pricing of the peak rate is “a bit too high, according to our assessment of the euro zone situation and the balance of power in the Governing Council,” he added.
Euro-Zone Private Sector Contracts in Dire Start to Quarter
The challenge for policymakers is to decide whether the 400 basis points of monetary tightening they’ve already implemented since last July — in addition to whatever they do on Thursday — is enough to tame inflation.
Data last week showed that inflation has slowed to 5.5% from almost double that at its peak, but that’s due more to a reversal in natural gas prices than the ECB’s action so far. Once energy and food are removed, so-called core inflation remains higher than 12 months ago.
“The US economy remains head and shoulders above the rest of the world. Period,” Win Thin, global head of currency strategy at Brown Brothers Harriman & Co., wrote in a note. “The Fed is widely expected to deliver a hawkish message.”
The UK’s bonds also rallied Monday, for much the same reason: S&P Global Market Intelligence said its index tracking sentiment among purchasing managers fell to 50.7 in July, compared to a consensus estimate of 52.3.
The yield on 10-year gilts fell as much as 11 basis points to 4.17% after traders reined in bets on the Bank of England’s peak rate. UK policymakers are due to meet next week.
--With assistance from James Hirai.
(Updates with Treasuries move and comment from second paragraph)
