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Euro zone government bond yields edge higher ahead of U.S. data

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German bond yields edged higher on Friday, but were still within striking distance of their lowest in almost four months as recession fears capped a tentative rebound earlier this week.

Investors await the U.S. Labor Department’s employment data for July. Signs that the U.S. job market continues to be robust will likely bolster expectations for more monetary policy tightening from the Federal Reserve and fueling recession worries, potentially lowering yields.

Meanwhile, the Fed kept delivering hawkish messages, with Cleveland Fed President Loretta Mester saying on Thursday that the central bank should raise interest rates to above 4% to bring inflation back to target.

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Germany’s 10-year government bond yield was 0.5 basis points (bps) higher at 0.808%.

German industrial production posted an unexpected but modest increase in June, official data showed on Friday, despite supply chain problems weighing on manufacturing.

“Today’s (U.S.) non-farm payrolls present a tougher test given the Fed’s tenaciously hawkish rhetoric,” Commerzbank analysts said in a note to clients.

“Another solid print is on the cards, and despite the recent adjustment, the front-end of the U.S. curve still seems exposed,” they added.

The part of the U.S. Treasury yield curve measuring the gap between yields on two- and 10-year Treasury notes reached 39.2 bps overnight, the deepest inversion since 2000.

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An inverted yield curve is usually a reliable indicator of a possible recession as the market discounts an economic slowdown, which would trigger rate cuts in the medium term.

German yield curve measured by the gap between 2 and 10-year yields flattened to 46 bps, just off its lowest in more than seven weeks at 43.5 bps.

Euro zone yields fell on Thursday after the Bank of England (BoE) raised rates but warned about recession risks.

“The market’s reaction to the BoE was symptomatic of the broader backdrop where recession fears have come to dominate, with the effect of flattening yield curves. The 2Y-10Y Gilt curve briefly inverted for the first time since 2019 around the BoE decision,” ING analysts said.

Italy’s 10-year government bond yields rose 1 bps to 2.95%, with the spread between Italian and German 10-year yields at around 213 bps.

In July, the Italian government of Mario Draghi collapsed, and the Italian-German yield spread widened from around 210 bps up to 260 bps.

Some analysts forecast further tightening as data from July showed that the bar for flexible Pandemic Emergency Purchase Programme (PEPP) reinvestments into BTPs was relatively low. (Reporting by Stefano Rebaudo; Editing by Shailesh Kuber)

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