LDN - Business

Divergent policy outlooks keep Germany-U.S. bond yield gap near one-month high

[February 16, 2017] By Abhinav Ramnarayan

LONDON (Reuters) - The spread between U.S. and German benchmark government bond yields were close to one-month highs on Thursday as the central banks of the two regions diverge on policy and political risks in Europe keep a lid on yields.

Expectations for a Fed rate hike potentially as early as next month have grown after hawkish comments from policymakers and data on Wednesday showing U.S. inflation recording its biggest gain in nearly four years.

These expectations have been pushing U.S. Treasury yields higher. Though German benchmark government bond yields, which normally move in sympathy with U.S. equivalents, also rose, the gap between the two is at 211 basis points, just 2 bps off one-month highs hit on Wednesday.

"The consolidation in the transatlantic spread has ended with the hawkish talks from the U.S.," said DZ Bank strategist Daniel Lenz. "Meanwhile tapering talk in Europe has faded with the ECB stating that it is not on the agenda and political risks keeping it from rising too much."

This has meant that while the yield on Germany's 10-year government bond <DE10YT=TWEB>, the benchmark for the region, has risen steadily since hitting its September trough of minus 0.16 percent, trading has been choppy.

On Thursday, for example, it fell 2 bps to 0.37 percent, coming off one-week highs hit on Wednesday. Other high-grade euro zone bond yields were also down 1-2 basis points.

The U.S.-German bond yield spread has been noticeably wider since the election of Republican Donald Trump as U.S. President fueled expectations of higher growth and inflation in the world's richest country.

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ELECTION CONCERNS

Upcoming elections in the Netherlands, France, Germany and possibly Italy, have kept investors interested in "safe" government bonds particularly with anti-euro and anti-EU sentiment on the increase throughout the continent.

Concerns have centered around France, with a presidential election coming up in April and May, but the country's debt agency on Thursday successfully sold over 7 billion euros of bonds in an auction, with demand topping 14 billion euros.

Also, Spain sold 4.5 billion euros ($4.8 billion) of debt at an auction on Thursday, including a tap of its 10-year benchmark bond.

Strong demand spilled over into the aftermarket, with the yield on Spain's 10-year bond falling 5 bps to 1.65 percent.

Markets will get a better idea of the degree of divergence between the two central banks later on Thursday when the European Central Bank publishes the minutes of its January meeting.

Consumer prices in the single currency bloc rose 1.8 percent in January, close to the ECB's target of just below 2 percent, ramping up the pressure on the central bank to reverse its ultra-loose policy stance.

But ECB President Mario Draghi has been at pains to stress that the data may be a one-off, fueled by an increase in commodity prices, and that the euro zone still needs monetary policy support.

"If there is any talk about rising inflation in Germany or European assets being overvalued, that might indicate that there are concerns among the most hawkish members about the current level of easing," Mizuho strategist Antoine Bouvet said.

(Reporting by Abhinav Ramnarayan; Editing by Alison Williams)

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