Bond Yields Decline as Economic Activity Weakens in Europe

Bond yields experienced a significant decrease on Wednesday following the release of data indicating a slowdown in economic activity across Europe. This decline in yields is reflective of an inverse relationship with prices.

Key Highlights

• 2-year Treasury Yield: The yield on the 2-year Treasury, BX:TMUBMUSD02Y, dropped by 4.7 basis points to 5.010%.
• 10-year Treasury Yield: The yield on the 10-year Treasury, BX:TMUBMUSD10Y, retreated by 6.4 basis points to 4.265%.
• 30-year Treasury Yield: The yield on the 30-year Treasury, BX:TMUBMUSD30Y, fell by 4.8 basis points to 4.356%.

Market Insights

The sharp decline in government bond yields can be attributed to the release of disappointing economic data from Europe. The eurozone composite purchasing managers index survey, which combines reports from the services and manufacturing sectors, revealed a decline in activity during August, reaching its lowest level in 33 months. Similarly, the United Kingdom displayed a surprising downturn in activity, hitting a 31-month low.

As a result of these discouraging figures, German 10-year bund yields (BX:TMBMKDE-10Y), which serve as the benchmark for the continent, plummeted by 10.1 basis points to 2.539%. Likewise, U.K. gilt yields (BX:TMBMKGB-10Y) with equivalent duration experienced a decline of 15 basis points to 4.504%. Traders responded to this data by adjusting their expectations for further interest rate increases by both the European Central Bank and Bank of England.

In response to this development, U.S. Treasury yields also decreased in sympathy ahead of the release of the S&P services and manufacturing PMIs for August, scheduled for 9:45 a.m. Furthermore, the July new home sales report will be published at 10 a.m. Eastern time.

Investors Await Powell's Speech at Jackson Hole Symposium

Investors will be closely monitoring the impact of the European economic slowdown on the Federal Reserve's decision-making process, as Chair Jerome Powell prepares to speak at the Jackson Hole symposium on Friday.

As of now, markets have priced in an 87% probability that the Fed will maintain interest rates at their current range of 5.25% to 5.50% during their next meeting on September 20, according to the CME FedWatch tool.

Looking ahead, there is a 38% chance of a 25 basis point rate hike to a range of 5.50% to 5.75% during the subsequent meeting in November.

Analysts predict that the central bank is unlikely to lower its Fed funds rate target to around 5% until July 2024, based on 30-day Fed Funds futures.

Additionally, the Treasury is set to sell $16 billion of 20-year notes on Wednesday.

Commenting on these developments, Althea Spinozzi, senior fixed income strategist at Saxo Bank, noted, "Before the much-anticipated Jackson Hole event at the end of the week, the U.S. Treasury will be conducting auctions for 20-year U.S. Treasuries today and 30-year TIPS tomorrow. Historically, investors tend to be cautious towards both maturities, particularly the recently reintroduced 20-year notes in the aftermath of the pandemic."

Spinozzi added, "The focus will be on the bidding metrics of both auctions and whether demand remains robust despite the recent surge in supply. The ongoing quantitative tightening and the withdrawal of Japanese investors also add to the equation. While U.S. Treasury yields continue to rise, it wouldn't be surprising to witness further increases, potentially pushing 10-year yields towards 4.5% and 30-year yields to 4.65%."