THE GREAT TRANSATLANTIC BOND DIVERGENCE UNWIND / THE WALL STREET JOURNAL

The Great Transatlantic Bond Divergence Unwind

The spread between U.S. and German bonds is narrowing, but this important indicator of global financial conditions has a long way to go

By Richard Barley

The Charging Bull and Fearless Girl statues sit on Lower Broadway in New York. Photo: Mark Lennihan/Associated Press


Many of the trades embraced by markets after President Donald Trump’s election have been slowly unwinding in 2017. Here’s an important one that could have further to go: the gap between U.S. and German government bond yields.

The spread between 10-year Treasurys and bunds ballooned after Mr. Trump’s November victory to a level not seen since before the fall of the Berlin Wall, around 2.3 percentage points by the end of 2016. U.S. yields rose sharply on the idea of reflation and stimulus, while Europe appeared stuck in a rut. At 1.75 percentage points, the gap is close to its pre-election level.

But even that is unusual by historical standards. Between 1990 and 2014, the spread was only rarely wider than one percentage point, and over that period averaged just 0.2 point, according to data from FactSet.

Such a tight relationship between German and U.S. bonds reflected the long global bull market for bonds in the glory years of globalization. Relatively synchronized monetary policy meant yields fell on both sides of the Atlantic together. The Fed’s 2013 taper, followed by signals of coming European Central Bank bond buying helped set the bond markets apart. That both helped weaken the euro and encouraged a rush of bond issuance by U.S. companies in European markets as borrowing costs fell.

Where policy goes now is key. Markets doubt how far the Fed might get with its tightening, and seem unflustered by the prospect of the central bank shrinking its balance sheet. Investors may be too relaxed, but in the absence of fiscal stimulus and inflation, much higher yields for Treasurys might be hard to achieve in the near term.

The European Central Bank, meanwhile, is set to move out of emergency-policy territory. Support for low yields on German bunds is likely to diminish as the ECB starts to move gently towards an exit from its bond purchases. While policy rates are likely to remain ultra-low for a long time to come, that implies a steeper yield curve in Germany, with the central bank exerting less influence over longer-term interest rates.

An important constraint on the ECB’s continuing bond purchases is in Germany; even though the ECB is talking about the flexibility of the program, any tweaks seem unlikely to result in larger purchases of bunds. Meanwhile, the eurozone economy is growing strongly, reducing the allure of German debt as a safe haven; the rise in the euro this year suggests that faith in the currency bloc is recovering. German yields still look out of sync with economic good news such as the record high in the influential Ifo business climate index.

The spotlight moves to ECB President Mario Draghi’s speech at the Fed’s Jackson Hole conference in August. His last appearance there in 2014 foreshadowed eurozone QE, sending the U.S.-German spread wider. This summer’s visit could bring the two sides closer together again.