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German yields touch six-week lows after Fed offers less hawkish outlook

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LONDON — German government bond yields fell to their lowest in six weeks on Thursday, encouraged by a rally in U.S. Treasuries the day before, after minutes from the Federal Reserve’s latest meeting showed policymakers were less hawkish than previously thought.

German 10-year yields fell 7 basis points on the day to 1.854%, the lowest since Oct. 5. Bund futures rose 0.6%, reaching their highest since early October.

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Markets show investors currently expect the Fed to raise rates by half a percentage point next month and for rates to peak around 5% by June, from a range of 3.75-4.00% right now.

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The Fed minutes did little to alter that outlook, given that they showed a “substantial majority” of members of the Federal Open Market Committee agreed it would likely soon be appropriate to slow the pace of interest rate hikes.

“The main takeway was the dispersion of views, which was probably a bit larger than expected, but it’s difficult to read too much into the trading because it’s been a really quiet week on the volume side of things,” Rabobank rates strategist Lyn Graham-Taylor said.

The European Central Bank publishes the minutes from its most recent policy meeting on Thursday. Investors currently expect euro zone rates to top out around 2.8% by the end of next summer.

“Here, as well, the market’s main focus is on the pace of rate hikes going forward. The ECB still hiked rates by 75bp last month, but subtle tweaks to the wording of the press statement were already interpreted as a dovish sign,” ING strategists led by Padraig Garvey said in a note.

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The discount of 10-year bonds to 2-year paper widened again, reaching its largest since mid-2008, reflecting investors’ belief that the European Central Bank is likely to jack up interest rates swiftly in the coming months, but not for long, as it balances protecting the economy with bringing inflation back towards its target of 2%.

The yield curve is already at its most inverted since mid-2008, sometimes perceived as a sign that investors believe recession is approaching and growth will slow.

The discount of 10-year yields to 2-year was last at -22 basis points, having widened by 41 basis points over the course of November alone – the largest monthly increase in the discount since May 2000.

The strength in core bonds flowed into peripheral debt, pushing Italian 10-year yields down by 5 basis points to 3.734%, marking a discount of 187 basis points to Bunds. Spanish 10-year bond yields also fell 6 basis points to 2.83%, while Greek debt eased by 1 basis point to 4.14%.

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A turning point for peripheral euro zone government bonds appears to be under way as more enticing yields and a European Central Bank backstop could rein in the risk premium for Southern European debt.

“We find it hard, from a strategic perspective, to rationalize the narrowing (in spreads), but from the way investors view the world, it’s difficult to argue against going long unless you have a very strong reason to do otherwise,” Rabobank’s Graham-Taylor said.

U.S. markets, including bonds, were closed for the Thanksgiving holiday on Thursday and will observe shortened trading hours on Friday.

The benchmark 10-year Treasury note fell by as much as 7 basis points on Wednesday to trade around 3.687%. It has fallen by 37 basis points in November, its largest monthly drop since March 2020. (Reporting by Amanda Cooper; Editing by Edmund Klamann)

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