Euro yields linger at 1-month lows as sinking oil calms inflation jitters

On Tuesday, European government bond yields remained stagnant, with German borrowing costs hovering near their lowest levels in more than a month and a half. The benchmark German 10-year Bund yield stood at 3.253%, unchanged from the previous day after falling to its lowest point in over six weeks on Monday. The two-year German yield, which is more sensitive to policy decisions, also remained flat at 2.979%.

Traders opted to remain cautious, not taking advantage of the dip. Crude oil futures continued to slide, falling another 1% to $91.56 a barrel, their lowest levels since early September and well below the $100 threshold. This drop in energy prices has put a dent in stagflationary concerns, as cheapening fuel inputs benefit European bond traders.

Throughout October, high oil prices had threatened to compress corporate margins and consumer inflation expectations, putting pressure on the European Central Bank to maintain high borrowing costs even as the regional economy slowed. However, with the energy sector cooling, that sharp inflationary tax is quickly dissipating, giving bond buyers confidence to hold yields near their recent autumn lows.

Despite the relief from the energy sector, European bond traders refrained from aggressively extending the rally on Tuesday, held back by the upcoming release of the U.S. Consumer Price Index (CPI) later in the day. The U.S. data will be crucial, as it will influence the Federal Reserve's future actions and transatlantic yield correlations.

Economists expect the October U.S. CPI report to show prices increasing at a moderate pace, but still remaining elevated enough to prompt the Federal Reserve into further action. With a blowout U.S. October jobs report last Friday, fixed-income markets have rapidly re-priced the Fed's terminal rate path, with traders now pricing in an 84% probability of a U.S. rate hike next month, up from 74% just a week prior, according to the CME FedWatch tool.

A hotter-than-expected inflation print could solidify these hawkish Fed expectations, exerting upward pressure on U.S. Treasuries and ultimately pushing European borrowing costs higher in response. Until the U.S. inflation data clarifies the transatlantic interest-rate spread, European bond traders seem content to hold steady in a narrow, defensive stance.