The rapid divergence between the euro area and US government bond markets is expected to continue as Europe's economy becomes increasingly lackluster and pressure on the European Central Bank to cut interest rates quickly increases.
While U.S. yields have risen in recent weeks, German yields have risen only slightly, pushing the closely watched 10-year gap between U.S. and German bond yields to about the widest since July. This increased to 183 basis points (bps). Yields move inversely with prices.
“We think these market dynamics need to continue,” said Simon Blundell, co-head of European fundamental fixed income at $11.5 trillion BlackRock, adding that U.S. bonds are more expensive than U.S. bonds. also said they prefer European bonds.
A sharp acceleration in U.S. job growth in September underscores the strength of the U.S. economy, while business activity in the euro zone unexpectedly contracted last month.
Traders now expect the U.S. Federal Reserve to slow after cutting interest rates by 50 basis points in September, but the ECB is expected to cut interest rates for the third time since June this week. It has become.
Goldman Sachs said the yield spread between U.S. and German government bonds is likely to rise to 200 basis points, the level seen earlier this year.
“We continue to expect European interest rates to outperform the US given weak data and central banks' reluctance to frontload,” the bank's analysts said in a note.
The widening yield gap is already spreading to other markets, pushing the euro to a nearly two-month low and pushing the dollar higher as investors gravitate toward U.S. Treasuries due to higher returns.
european spatter
Germany's finance ministry said last week that Europe's largest economy is likely to contract for the second year in a row in 2024. Germany's once-powerful manufacturing industry continues to struggle due to the energy crisis triggered by the war in Ukraine.
“The numbers are really bad,” said Michael Widener, co-head of global fixed income at Lazard Asset Management. “There are no hard numbers that are being reported, there are no soft numbers on the outlook and various indicators. Everyone is feeling pretty gloomy, and the mood has gotten even worse.”
Meanwhile, France has promised tax increases and spending cuts to reduce its budget deficit. This is seen by many investors as necessary, but it will weigh on the growing economy of the euro zone's second-largest economy.
Rheinout de Bock, head of European rates strategy at UBS, said interest rates in the euro zone could fall to 1% next year if growth does not accelerate, adding that France's deficit cuts will be a drag. . The economic slowdown in China, a major trading partner, is also a cause for concern for investors.
In contrast, a strong September jobs report eased concerns about a sharp U.S. economic slowdown, with investors expecting the Fed to cut interest rates by 50 bps ahead of its second meeting in November. This resulted in the elimination of
In September, the Organization for Economic Cooperation and Development announced that the U.S. economy is expected to expand by 2.6% this year and 1.6% in 2025, while the euro zone's growth rate is 0.7% and 1.3%. It was %.
deep rate cut
Traders expect the ECB to stop cutting interest rates at about 2% in the second half of next year, well above the sub-zero levels seen before the coronavirus pandemic. The ECB's main interest rate is currently 3.5%.
But Bank of America analysts are skeptical that the eurozone economy can sustain interest rates at 2%, with many economists calling the level “neutral” or stimulating economic activity. We believe that this is a level that does not require any restraint.
“Today's world is not that different from the world in 2017-2018. Domestic private demand remains surprisingly weak,” BofA strategists led by Ralph Preusser said last week. BofA expects European bond prices to rise.
Not all investors are pessimistic about the eurozone's prospects, pointing to strong growth in countries such as Spain and Italy.
“European data is looking good and is actually better than expected,” said Lloyd Harris, head of fixed income at Premier Mitten Investors.
Harris said he believes the market has priced in too many rate cuts and expects bond yields to rise more in the United States than in Europe.
“The United States is just a little bit different in that there is a willingness to increase government spending and further widen the budget deficit, and that's what's driving the American economy forward.”
