October 14, 2019 / 7:07 AM / a month ago

Euro zone bond yields fall from 2 1/2-month highs as caution returns

* Euro zone periphery govt bond yields tmsnrt.rs/2ii2Bqr

By Dhara Ranasinghe

LONDON, Oct 14 (Reuters) - Euro zone bond yields fell on Monday, pulling away from last week’s 2 1/2- month highs, as a note of caution surrounding both Brexit and U.S./China trade talks encouraged investors back into fixed income.

Britain and the European Union said on Sunday a lot more work would be needed to secure an agreement on Britain’s departure from the EU, pushing sterling down early on Monday.

U.S. and Chinese officials also said more work is needed before a trade agreement can be reach, even though U.S. President Donald Trump on Friday outlined the first phase of a deal to end the trade war and suspended a threatened tariff increase set for Oct. 15.

Data from China underlined the bitter trade war with dollar-denominated exports and imports both falling by more than expected in September.

“The aggressive selloff of the last few days is not justified by the reality in terms of the economic situation, and in terms of the trade developments that are feasibly possible given the differences between the two sides,” said Peter McCallum, rates strategist at Mizuho in London.

“We do not expect improvement on the trade front to be sufficient as to prevent a material slowing in the U.S. economy.”

Having sold off on Friday amid growing optimism about a Brexit deal and U.S.-China trade talks, bond markets across the euro area rallied on Monday, pushing yields lower.

In Germany, the euro zone’s benchmark bond issuer, 10-year bond yields fell 3.5 basis points to -0.48%, below Friday’s 2 1/2-month high of -0.427%.

Germany’s 30-year bond yield, which pushed back above 0% late last week, tumbled 5 bps to 0.03%.

Ten-year bonds yields in France, the Netherlands and Italy were also down around 4 bps each .

“Brexit dynamics matter immensely for European bond markets and (last week’s) news flow supports our negative view on Germany,” James McCormick, global head of desk strategy at NatWest Markets said in a note.

Unexpected signs of progress between the Irish and British governments on Brexit last week boosted hopes that one source of uncertainty that has hurt the growth outlook in world markets might finally be lifting.

The Federal Reserve’s preferred measure of the yield curve, the gap between three-month and 10-year Treasury yields , on Friday reverted for the first time since mid-July, as progress in U.S.-China trade talks boosted the U.S. economic outlook.

Reporting by Dhara Ranasinghe, editing by Larry King

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