Euro bond yields at new lows after US yield curve inverts

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Government borrowing costs in Germany fell to record lows on Wednesday as global recession fears grew, with the US Treasury yield curve inverting for the first time since 2007 and Germany reporting its economy shrank in the second quarter.

Eurozone government bond yields extended earlier declines after the two- to 10-year Treasury yield curve inverted, a sign that investors are bracing for recession risks in the United States.

The yield curve is closely watched for recession signals. The last time it inverted was during the US sub-prime-mortgage crunch that set off the global financial crisis.

“What this means is that markets are signaling that central banks are running out of options ... it points to a bigger, broader picture of major industrial economies such as China and Germany hemorrhaging growth,” said Stephen Gallo, European head of FX strategy at BMO Markets.

Yield curves across Europe flattened as the curve between Germany's two- and 10-year bonds shrank to 24 basis points, the narrowest since 2008. In the United Kingdom, shorter-dated borrowing costs fell below 10-year gilt yields, for the first time since 2008.

Germany's gross domestic product fell 0.1 percent quarter-on- quarter after growing 0.4 percent in the first quarter, the latest sign that world trade disputes are damaging Europe's biggest economy.

The 10-year German bond yield fell to -0.64 percent, a record low that takes its decline this year to almost 90 basis points. Its 30-year bond yield also hit a record low at -0.173 percent.

Across the eurozone, most long-dated bond yields were down three to six basis points.

“The drop in the ultra-long end was swap-driven last week, but now it is changing to the cash market, which shows there is a more fundamental driver to [the move lower in] long dated bond yields,” said Rainer Guntermann, rates strategist at Commerzbank.

News on Tuesday that Washington would delay tariffs on some Chinese imports sparked a surge in world stock markets, but demand for fixed income also remained strong.

Analysts put that down to a weakening global economy as well as risks ranging from Brexit to turmoil in Hong Kong, a rout in Argentina's financial markets and political uncertainty in Italy.

“There is a lot of pessimism pervading in the euro zone bond market and that reflects the easing that's expected from the ECB (European Central Bank),” said Antoine Bouvet, senior rates strategist at ING in London. “This also helps explain why the bond market hasn't really reacted significantly to the headlines on trade.”

Elsewhere, Italian bond yields fell for a third straight session as Italy's Senate slowed a government crisis.

The Senate on Tuesday postponed until next week debate on the country's government crisis, frustrating a push by Matteo Salvini, leader of the far-right League party, for new elections.

Italy's 10-year bond yield fell three basis points to 1.59 percent, narrowing the gap over safer German Bund yields to 222 basis points – down from Friday's five-week high of 239 basis points.