A rapid divergence between euro zone and U.S. government bond markets is expected to continue, as an increasingly lacklustre European economy adds to the pressure on the European Central Bank to quickly cut interest rates.
The closely-watched gap between U.S. and German 10-year bond yields has risen to its widest since July at around 183 basis points (bps), as U.S. yields have climbed in recent weeks while the German ones have ticked up only slightly. Yields move inversely to prices.
We think these market dynamics have further to run,” said Simon Blundell, co-head of European fundamental fixed income at $11.5 trillion asset manager BlackRock, who favours European over U.S. bonds.
While September’s sharp acceleration in U.S. jobs growth highlights the strength of the U.S. economy, euro area business activity contracted unexpectedly last month.
Traders now expect the U.S. Federal Reserve to slow down after a 50-basis point rate cut in September, but the ECB is this week tipped to deliver its third rate cut since June.
Goldman Sachs said the U.S.-German bond yield gap is likely to rise to 200 bps, a level last seen earlier this year.
“We continue to expect European rates to outperform the U.S, with data weaker and a central bank less willing to front-load,” the bank’s analysts said in a note.
The widening yield gap is already spilling over to other markets, with the euro falling to its lowest level in around two months as higher returns draw investors towards U.S. bonds, boosting the dollar.
