Land of Sub-Zero Yields Is a Hero in Saga of Global Policy Shift

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Land of Sub-Zero Yields Is a Hero in Saga of Global Policy Shift

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Jill Ward and James Hirai
·4 min read
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(Bloomberg) -- The land of sub-zero yields is suddenly back in favor as the Federal Reserve breaks ranks with its global peers.

The European Central Bank is content to keep pumping liquidity into bond markets even as the Fed starts discussions to taper pandemic stimulus. That’s sparked the biggest divergence in short-dated U.S. and German government bonds this year -- and AllianceBernstein and Jefferies International are betting it’s just the start of a regime shift that will flow through to bonds across the curve.

“The ECB is still in it for the long haul,” said John Taylor, a fund manager at AllianceBernstein. He’s selling short long-dated Treasuries and is overweight the belly of the European curve, particularly in Italy. “We think at this stage, the likely move higher in U.S. yields outright and versus Europe is sufficient to be underweight.”

This week, public pronouncements from officials on both sides of the Atlantic made it clear that the Fed is leading the global race to rein in the extraordinary measures put in place during the coronavirus crisis. Inflation and growth are accelerating quicker than policy makers were expecting in the U.S., while in Europe those pressures are more subdued.

It’s a contrast ECB President Christine Lagarde took pains to underline, saying the risks of an inflation spillover to Europe are limited. European policy makers have pledged to continue bond-buying at a faster pace through the third quarter even as the recovery kicks into gear.

After Lagarde’s reassuring words halted a bond selloff in Europe on the Fed’s hawkish shift, the gap between German bunds and two-year Treasury notes moved wider. Now fund managers are betting the divergence trade will percolate through to 10-year benchmarks -- and beyond.

“The two are in a different monetary cycle phase,” said Mohit Kumar, a managing director at Jefferies International. He’s targeting the 10-year yield premium to widen to 200 basis points, from 166 basis points currently. “The Fed has let the cat out of the bag on tapering and eventual rate hikes.”

The Fed is expected to move gradually, with rate liftoff expected in 2023, and no decisions on tapering asset purchases for several more months. At the ECB, officials avoid even talking about exiting programs for fear of upsetting a delicate balance of low yields that have kept many of the region’s companies afloat through the pandemic.

Others are advising clients to buy up the debt of peripheral nations that stand to benefit most from ECB largesse. Strategists at Barclays Plc recommend buying Spanish 10-year bonds as a tactical trade given the ECB’s relatively dovish stance.

Primary markets are also about to get an influx of new debt as the European Union returns for another tranche of debt under the so-called NextGenerationEU program that saw it raise 20 billion euros earlier this month.

The ECB has been pointing to very big differences with the U.S. and “will be very reluctant to jump on the bandwagon,” said Ronald Van Steenweghen, a money manager at Degroof Petercam Asset Management. “Euro rates will likely to move less in tandem with U.S. rates than before.”

Here are some key events in the bond market taking place next week:

Debt sales next week from Italy, France, Spain and Belgium total about 25 billion euros according to Commerzbank AG strategists who also expect a second NGEU offering. Bond redemptions from Germany and Italy total 32 billion euros, while both also pay coupons of about 7.2 billion euros.The U.K. sells 3.5 billion pounds of new three-year bonds and the BOE will buy back 3.4 billion pounds of debt across three operationsInflation numbers dominate the coming week’s data releases, with German numbers on Tuesday followed by the euro area’s flash estimate on Wednesday; U.K. data is mostly second-tier and backward lookingECB speakers are headlined by President Christine Lagarde on Tuesday and Friday; Jens Weidmann, Luis De Guindos and Francois Villeroy on Monday and TuesdayBOE Governor Andrew Bailey gives the annual Mansion House speech on Thursday; Andy Haldane speaks on Monday and Wednesday

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