Two years ago, investors expected the end of European Central Bank’s experiment with ultralow interest rates and embarking on the path of normalizing its monetary policy, catching up with the Federal Reserve.
In a reversal, traders are now betting on U.S. rates to fall and converge with Europe, where government borrowing costs are at or below 0%.
A buildup of wagers on re-coupling interest rates has tightened the gap between yields in the U.S. versus the German bond market, a proxy for eurozone debt as it is the biggest economy in the 19-member currency bloc.
The difference in yields between the 10-year maturity for the U.S. Treasury and German bond stood at 1.61 percentage points on Thursday, after narrowing 1.20 percentage points from February 2018.
On Thursday, the yield for the 10-year Treasury note
TMUBMUSD10Y,
fell 4.8 basis points to 0.944%, while the 10-year rate for the German government bond
TMBMKDE-10Y,
or bund, traded at negative 0.666%. Bond prices move in the opposite direction of yields.
Instead of institutional investors revolting against the sea of negative rates in Europe and sending German yields higher, the narrowing spread has mostly come from the relentless slide in long-dated Treasury rates as the U.S. central bank apparently abandoned its rate-hike process beginning at the end of 2015 to lowering benchmark fed-funds rate by 1.25 percentage points to its current 1%-1.25%-range.
Further tightening the gap between bunds and Treasurys, the Fed carried out an emergency 50 basis-point rate reduction on Tuesday, citing concerns about the potential impact from the COVID-19 outbreak, which promises to dent consumer confidence and hamstring a U.S. economy in its record-setting 12th year of expansion.
The bund-Treasury spread is expected to narrow further because economists speculate that the Fed might be inclined to lower fed-funds by another 50 basis points at its coming March 17-18 meeting.
“Even if we avoid a recession, the Fed may well cut interest rates by at least another 50 basis points before it is done,” wrote analysts at BCA Research, in a Wednesday note.
For investors looking to buy ballast in their overall portfolios, U.S. Treasurys have become one of the few places to find positive yields among developed-market economies, a feature that may only drag yields lower.
“If you’re looking to hedge your portfolio, do you want to buy Treasurys or do you want to buy bunds?” said Gregory Faranello, head of U.S. rates at AmeriVet Securities, who added that most investors would choose higher-yielding U.S. debt as long as considerations around currency hedging costs were stripped away.
A few years ago, famed money managers including Bill Gross bet on a tighter yield gap between Treasurys and German bunds. Part of that thesis, for some investors, was the expectation that ultralow interest rates in Europe were unsustainable and that the ECB would eventually normalize monetary policy in line with the Fed. However, Gross, like many others, couldn’t precisely time his those bets.
For one, the eurozone’s growth woes prevented the ECB from lifting rates, even as the Fed carried out nine quarter-point rate increases between the end of 2015 and the end of 2018. This blew out the Treasury-bund spread to its widest levels in decades in February 2018, along with the divergence of the Fed and the ECB’s interest-rate path.
It is thus striking that spreads have tightened so dramatically for the reverse reason — the Fed is now following the cue of other advanced central banks and pushing rates closer to zero.
“We’re now having the opposite phenomenon,” said Farnaello.
Source : MTV
