Euro zone bonds stabilise, France gains brief respite

By Amanda Cooper

LONDON, Oct 23 (Reuters) - Euro zone bonds opened on a steadier footing on Friday, shaking off some of the volatility and worry over the finances of France and other fragile economies while boosting the perceived safe havens earlier in the week.

A safe-haven rally driven by renewed concern about the longer-term profitability of the AI trade and the impact on global growth drove a powerful drop in US Treasury yields overnight, which pushed the 10-year yield down nearly 20 basis points, marking the biggest one-day fall since March 2023.

This week has brought a clear split between the bonds of euro zone countries with large debt burdens and those with healthier finances. French yields , which were down 3 basis points at 5.06% in early trading, have risen nearly 28 bps this week, the most out of any euro zone country and the most in a week since late May, followed by Belgian yields , with a rise of 17 bps and Italian , up 10 bps.

German and Dutch 10-year yields , , meanwhile, have fallen 7.4 bps and 6 bps, respectively.

German Bund yields were flat at 3.342%, while Dutch yields edged up 1 bp to 3.452% on Friday.

This has pushed the risk premia for the French and Belgian governments, meanwhile, to their highest in well over a decade.

Next week brings a series of major central bank decisions, including those from the Federal Reserve, the Bank of Japan and the European Central Bank.

The ECB, along with the other two, is expected to leave rates unchanged, meaning investors will be anxious to hear what President Christine Lagarde says about the outlook, but also about whether stress in French bonds could become a market flashpoint.

"Given the latest stress, yesterday led to fresh questions about whether the ECB would even be able to hike rates again this year. Admittedly, that’s still the baseline market expectation," Deutsche Bank strategist Jim Reid said.

"But with a 69% chance of another hike priced by December, this represented a sharp pullback from 90% at the close on Wednesday. So doubts on the sustainability of further ECB hikes are rising," he said.

Money markets were back to pricing a roughly 80% chance of a rate rise by December on Friday morning, according to LSEG data .

This week's 4% rise in crude oil futures above $110 a barrel on the back of renewed Houthi attacks on Gulf infrastructure, which would normally weigh on bonds, given the likely increase in inflation, has been relegated to the background in the bond market.

Investors are fretting over when and how the builders and providers of AI will see a return on the trillions of dollars they are deploying in the rollout, which has reignited government bonds' role as a safe haven, particularly those outside the euro zone.

Yields on Japanese government bonds and US Treasuries have fallen more sharply even than German yields this week, down 14 bps, 12 bps, respectively, while those of UK gilts were down 4 bps.