A rally swept across European government bond markets on Friday, pushing French 10-year bond yields to record lows for the first time after a weak US jobs report re-ignited bets that the Federal Reserve could deliver a rate cut soon. Bonds yields from Cyprus to Ireland had already plumbed all-time lows earlier in the day. And data showing a sharp slowdown in US jobs growth last month, suggesting a loss of economic momentum was spreading to the labour market, lit another fire under the market.
With US Treasury bond prices rallying hard, the euro zone followed suit. French 10-year yields touched 0.065%, surpassing the previous low hit in 2016. Italian yields fell as much as 20 basis points to a new one-year low of 2.28% and their spread over Germany narrowed to the tightest in a month.
German 10-year yields hit a new record low at minus 0.26%. Twenty-year yields also hit a record low at just 0.12% and the gap between 2 and 10-year German yields was at is narrowest since 2014 at 38 bps. "The payrolls data plays into the argument that the Federal Reserve will have to cut interest rates sooner rather than later," said Chris Scicluna, head of economic research at Daiwa Capital Markets in London.
"The cycle has peaked and there could be a series of rate cuts." US non-farm payrolls increased by 75,000 last month, falling below the roughly 100,000 needed per month to keep up with growth in the working-age population. The weak US data came a day after the European Central Bank ruled out raising interest rates in the next year and even opened the door to cutting them or buying more bonds as risk factors such as the global trade war and Brexit drag the euro zone economy down.
Data earlier on Friday showed German industrial output and exports dropping more than expected in April while the Bundesbank slashed growth projections for the bloc's largest economy. "We are now operating in a world that is no longer normal, which warrants a lower-for-longer policy and keeping rates at present levels until mid-2020," said Mondher Bettabieb-Loriot, head of corporate credit at Vontobel Asset Management.
Money markets upped their bets on an ECB interest rate cut, pricing in a 60% chance of one by year-end, versus 45% on Thursday. The market had initially appeared disappointed with the ECB's policy response, with the euro strengthening and yields rising on Thursday. But that mood changed on Friday as investors again hovered up euro zone bonds in anticipation of monetary stimulus.
A key market gauge of long-term eurozone inflation expectations, the five-year, five-year breakeven inflation rate, dropped to a new record low below 1.23%. It has dropped 15 bps in the past month. Dutch, Irish, Spanish and Portuguese 10-year bond yields all hit record lows. Even yields on Italian bonds, viewed as more risky than their peers, tumbled, as investors bet on more ECB stimulus. Italian 10-year yields ended the day almost 15 bps lower - their biggest one-day fall since December.