Spread Between US Treasuries and Bund All time High

JPMorgan CEO Jamie Dimon said this week that yields currently should be at 4 percent, and are more likely to get to 5 percent than most people realize.  Yet the yield on the 10-year Treasury bond remains stubbornly below 3 percent and yields on the 10-year German government bonds, also known as Bunds, are only slightly above zero.

As a result, the 2-year, 5-year and 10 year yield spreads of US Treasuries vs Bunds has hit all time high!  This would encourage flow of funds out of the euro into the dollar.

The Fed remains steady on its course of raising rates, while the European Central Bank has said its earliest rate increase will be more than a year from now. Prospects of a growing divergence between the policies of these two central banks are motivating hedge funds and other speculators to engage massively in “currency carry trades.” This means borrowing funds in euros at virtually zero interest and investing them in dollar-denominated bonds with returns near 3 percent. These trades can rake in so much money that even a sudden reversal in exchange rates poses little risk.

Christoph Rieger, a German analyst at Commerzbank, frets that this development will hit US stocks, because investors will find the bond yield more attractive and safer than dividends from stocks.

Everyone seems to agree that such a divergence in interest rates cannot last in a global economy. “No economic region can decouple itself from the world in the long run,” said Jörg Warncke at Union Investment. “In the long term, interest rates in the US and Germany will converge.”

For this reason, the legendary bond investor Bill Gross is positioning himself for a decline in US yields and an increase in German yields — the exact opposite of Mr. Dimon’s expectations. Mr. Gross has been wrong before, which is one of the reasons he is now at Janus Capital and no longer at Pimco, an erstwhile tiny investment firm that he built into a bond powerhouse. But it may be that an active and experienced trader like Mr. Gross wins out over a bank manager like Mr. Dimon, no matter what his economists are telling him.

Reference:

Handelsblatt Global, Andrea Cinnen, 2018-08-07, “Diverging interest rates lure speculators into US bonds, denting the euro”