US-Germany bond yield gap near 29-year highs

US BONDS UNDERPERFORM AS FED RATE HIKE EXPECTED NEXT MONTH

The gap between US and German 10-year benchmark bond yields was a shade off its widest level in nearly three decades yesterday as the economic and monetary policy outlooks of the two regions start to take different paths.

In thin trading yesterday with much of Europe on May Day holiday, US 10-year Treasury yields rose above 2.96 per cent briefly, extending the gap over the German equivalent.

The dollar was its strongest against a basket of currencies since early January on increased expectations that the US Federal Reserve will raise rates three more times this year to add to the one hike already done.

Core Eurozone bonds, on the other hand, have picked up demand in recent days sine a European Central Bank meeting on expectations that policymakers will adopt a relatively cautious stance.

“Higher US core PCE [personal consumption expenditures] inflation and Wednesday’s FOMC meeting should pave the way for a June hike [from the Fed],” Commerzbank analysts said in a note.

However, subdued inflation on the other side of the Atlantic, along with redemptions and other technical factors, should stabilise European government bonds, they added.

The gap between 10-year German and US bond yields was at 240 basis points, less than a basis point off the widest level since March 1989 touched last week.

Though this spread does not account for the different valuations of the currencies of either region, it still indicates how differently investors view the two regions in terms of how far central banks have to go in removing post-crisis stimulus.

The European Central Bank still buys €30 billion (Dh133.31 billion) of bonds a month as part of its stimulus programme and rate hikes are still far away by investors’ reckoning, whereas the Fed is already running down its quantitative easing scheme.

Sharp shifts on rates

In addition, the gap between British and US 10-year government bond yields hit its widest since 1984 yesterday, reflecting sharp shifts in interest rate expectations in the two countries in recent days.

Most Eurozone bonds were roughly unchanged on the day, Italian yields rose a touch, having jumped 3-5 basis points across the curve on Monday on political jitters.

The Italy/Germany 10-year bond yield spread yesterday reached its widest in two weeks at 123 basis points following headlines yesterday that raised the possibility of an early election.

5-Star leader Luigi Di Maio called for early elections in June, saying efforts to form a coalition after last month’s inconclusive vote had gone nowhere.