German Bunds hits two-week lows on Friday after surprisingly strong US jobs gains despite a partial government shutdown fuelled expectations the Federal Reserve could trim its stimulus earlier than thought. A rally in euro zone debt triggered by a European Central Bank rate cut the previous day reversed after the data showed US employers added 204,000 jobs to payrolls in October versus a Reuters forecast of 125,000.
Bund futures dropped nearly a percentage point to 140.87, their lowest since October 25, driving German 10-year yields 7 basis points up to 1.76 percent. Bunds outperformed US Treasuries, driving their 10-year yield gap to its widest in two months around 100 basis points as the US data highlighted the monetary policy divergence between the ECB and the Fed.
"Combined with the Q3 GDP figures yesterday it (the US jobs report) suggests that the US economy has been quite resilient to the government shutdown hence increasing the risk that the Fed may taper before March next year," said RIA Capital Markets strategist Nick Stamenkovic. "As a result Treasuries have fallen sharply and that's dragged down Bunds. Monetary policy divergence will remain a key theme in the market going forward ... hence the spread between Treasuries and Bunds will continue to widen."
Other euro zone bonds were also pummelled, with a Standard & Poor's cut of France's sovereign rating by one notch to AA late on Thursday having a muted impact on French debt. French 10-year yields were last 6 bps up at 2.23 percent with Dutch yields up a similar amount at 2.10 percent and Belgian equivalents 5 bps higher at 2.47 percent.
"The downgrade itself is largely immaterial - but the reasons for downgrade hold. France will find itself as a credit risk should it fall back into recession," Patrick Armstrong, CIO of Armstrong Investment Managers, said in the Reuters Global Markets Forum. "We have been short OATs for much of the year, but closed the position a couple of months ago. The rate cut was more of a positive for bonds, than the downgrade is a negative. Should rates get back to 2.1 percent, we will be short again."
Peripheral bonds also fell as investors cashed in on ECB-led gains made the previous session, but analysts expected Spanish and Italian debt would continue to benefit from the ECB's accommodative stance. "Yesterday's decision is very supportive for peripheral bonds as now core bonds are even more rich," said Cyril Regnat, fixed income strategist at Natixis.
"We still favour carry trade strategies by buying some Spanish or Italian short bonds in the 1 to 3 year area and financing them in the repo market." Italian 10-year yields were up 6 bps at 4.15 percent while Spanish equivalents were 6 bps higher at 4.13 percent.
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