Euro zone government bond yields edged lower on Tuesday as escalating Russia-Ukraine tensions deepened fears of a new war in Europe, boosting demand for safe-haven assets.
President Vladimir Putin ordered the deployment of troops to two breakaway regions in eastern Ukraine after recognising them as independent, drawing international condemnation with the West set to announce new sanctions against Russia.
Investors expect central banks to delay their exit plans from pandemic monetary stimulus until a diplomatic solution of tensions over Ukraine is in sight.
Euro zone money markets showed investors scaled back their expectations for a European Central Bank rate rise in 2022, pricing in an around 95% chance of a 10 basis points (bps) rate hike in July and of 40 bps rate hikes by year-end.
Money markets were fully pricing in a first, 10 bps rate hike by June 2022 and 50 bps worth of hikes by December following the ECB's Feb. 3 meeting until last week.
German business morale improved in February, despite the Ukraine crisis, as businesses hope for an end to the coronavirus crisis, slightly boosting yields.
Germany's 10-year government bond yield fell 0.5 bps to 0.192.
The German 5-year yield hit its lowest since Feb. 3 at -0.116%, while the 2-year yield was at its lowest since Feb. 1 at -0.517%.
Bond yields move inversely to their prices.
"Tensions over Ukraine seem likely to last longer than expected, and, in such a situation, there are increasing probabilities that ECB will delay its monetary tightening," Mauro Valle, head of fixed income at Generali Investments Partners, said.
He added that money market expectations pricing two rate hikes in 2022 "are slightly exaggerated", and he forecast the ECB would raise rates "just once this year even if geopolitical tensions dissipate".
"While the current turmoil is suggesting that the extreme attractiveness of Bunds will not fade quickly, an opportunity should arise once the dust surrounding geopolitics settles and exaggerated tightening fears regarding monetary policy in the euro area cool down," Unicredit analysts said in a note.
Some in the markets were watching moves in 5-year Russian credit default swaps (CDS) or rouble intraday.
"In early 2015, the 5y Russia CDS widened to above 600bp more than half a year after the annexation of Crimea when the sanctions started to bite, and the Russian economy slid into recession," Commerzbank analysts said in a research note to clients. Russia's 5-year CDS was at 310 bps.
"This time, things would probably happen quicker," as there was a lot of widening potential left in the CDS, they added.
Italy's 10-year government bond yield fell 1.5 bps to 1.9%, with the closely watched spread between Italian and German 10-year bond yields flat at 169.
(Reporting by Stefano Rebaudo, editing by Alex Richardson) ((stefano.rebaudo@thomsonreuters.com; +390266129431;))
