Germany's 10-year yield drops below 1% as growth fears in focus

By Yoruk Bahceli

(Reuters) - Germany's 10-year bond yield fell below the closely watched 1% level on Thursday, a day after a slump in U.S. stocks brought growth fears back into focus.

European shares were lower, following a selloff in U.S. equities and a sharp drop in Treasury yields on Wednesday, when retailer Target lost around a quarter of its market value, highlighting worries about a U.S. economy hit by surging prices.

Germany's 10-year yield, the benchmark for the euro area, was down 6 bps to 0.95% by 1447 GMT.

The two-year yield, sensitive to interest rate expectations, was down 1 bp to 0.36%.

That flattened the two-year/10-year segment of Germany's yield curve another 5 bps to 59 bps. The curve has flattened sharply this week, similar to moves in the U.S., in another sign of growth concerns.

Investors scaled back their bets on rate hikes from the European Central Bank slightly, now expecting around 106 bps of hikes by year-end, compared to 110 bps on Wednesday.

"It's a catch-up with the decline in equities in the U.S. that carried on post-European market close and the decline in Treasury yields that also carried on," said Lyn Graham-Taylor, senior rates strategist at Rabobank.

"The interesting dynamic here that shows you the focus on the negative growth side is that you're actually seeing peripherals widen and some pricing out of the ECB hike expectations... It shows it's a growth-led move," he added.

Italy's 10-year yield was 4 bps lower, widening the closely watched risk premium over German bonds to 195 bps, from 192 bps on Wednesday.

Growth concerns also hit corporate bonds, sending Markit's iTraxx Europe crossover CDS index, which measures the cost of insuring against defaults on a basket of underlying high-yield bonds, to the highest since May 2020 at 493 bps.

The main index, which measures the cost of insuring exposure to investment-grade corporate bonds, rose above 100 bps to the highest since April 2020.

Elsewhere, the three-month Euribor interbank borrowing rate has risen 5.5 basis points this week, the biggest weekly jump since the height of market panic over the COVID-19 pandemic in April 2020, which had tightened financial conditions.

Fixed at -0.348% on Thursday, the rate was at its highest since June 2020.

"A rate hike by the ECB at the July meeting is very likely... This will lift euro zone money market rates, which will rise, due to monetary policy, for the first time since April 2011," said Luca Cazzulani, head of strategy research at UniCredit.

(Graphic: Three-month euribor, https://fingfx.thomsonreuters.com/gfx/mkt/dwvkrnaropm/3m%20euribor.png)

There was little market reaction to the minutes of the European Central Bank's April meeting, which showed policymakers expressed widespread concern about the spread of inflation, with some members viewing it as important for the bank to normalise policy without undue delay.

ECB communication has moved rapidly since the meeting, with policymakers calling publicly for a positive policy rate this year and one not ruling out a 50 basis-point rate hike.

(Reporting by Yoruk Bahceli; Editing by Bernadette Baum, Kirsten Donovan and John Stonestreet)