Big investors are selling U.S. Treasuries and buying European government bonds, betting that if Europe's inflation slows, central banks will be able to start cutting interest rates sooner than the Federal Reserve.
Wealth managers at Pimco, JPMorgan Asset Management and T. Rowe Price have all increased their exposure to European government debt in recent weeks.
That pushed the so-called spread, or gap, between the benchmark 10-year borrowing costs between Germany and the United States to 2 percentage points, near its highest level since November.
“The path to lower interest rates in Europe is clearer than in the U.S.,” said Bob Michel, chief investment officer and global head of fixed income at JPMorgan Asset Management. “It's hard to see an economic reason for the Fed to cut rates.”
He added that he now owns more European government bonds than usual and is “growing his holdings.” [the] Direction for further acquisition.”
The shift comes as the U.S. and European economies begin to diverge, with expectations growing that the ECB will cut rates more than the Fed this year as inflation slows and Europe's economy weakens. .
Markets are currently pricing in three or four rate cuts from the ECB by the end of the year, compared to just two or three from the Fed.
Government bonds on both sides of the Atlantic have sold off this year, pushing yields higher as investors back down on expectations of an impending rate cut.
However, the move was even stronger in the United States, where the benchmark government bond yield rose 0.5 percentage point to 4.4%. In comparison, comparable German Bundeswehr bonds rose 0.3 percentage points to 2.4%.
Andrew Boles, Pimco's chief investment officer for global fixed income, said he has favored European and British government bonds over U.S. Treasuries this year as there is “more evidence that inflation is correcting.”
Pimco, which manages $1.9 trillion in assets, lowered its forecast for a Fed rate cut this year by three quarter points to two quarter points after Friday's blockbuster jobs report.
Economists expect U.S. inflation data for March to be released on Wednesday to rise to an annual rate of 3.4%. Statistics for January and February have already exceeded analysts' expectations.
In contrast, inflation in the euro zone fell to a weaker-than-expected 2.4% last month, raising hopes that the ECB would cut interest rates by the summer.
Quentin Fitzsimmons, senior portfolio manager at T. Rowe Price, which manages $1.4 trillion in assets worldwide, said: “We prioritize euro zone bonds, including German federal bonds, and we prioritize U.S. bonds.'' I prefer to be underweight.”
He said his confidence in the ECB's June rate cut was “high,” but said the positive U.S. data had prompted the Fed to “backtrack from its previously clear intention to start cutting rates.”
Fitzsimmons said if the ECB starts cutting rates sooner than the Fed, lower interest rates will make holding eurozone bonds less costly to hedge compared to U.S. Treasuries.
He said this could “further support the idea that German Bunds are outperforming relative to US Treasuries.”
But some analysts have warned that if the ECB goes too far ahead of the Fed in cutting interest rates, there is a risk that the euro will weaken significantly and inflation will rise again.
“There's a good chance the divergences will be this large to start having a significant impact on currencies,” said Mike Pond, head of global inflation research at Barclays. “If the Fed doesn't cut rates similarly, it may be difficult for the ECB to cut rates as much as we expect.”
Nevertheless, the inflation outlook is currently more benign in Europe than in the US. The European Central Bank forecasts annual inflation in the euro area in 2024 to be 2.3% and growth to be 0.6%.
By comparison, the U.S. central bank's preferred measure of inflation, the Core Personal Consumption Expenditure Index, is expected to fall to 2.6% this year from the current 2.8%, compared with the Fed's forecast.
The US central bank expects growth to be 2.1% by the end of the year.
“Growth in the U.S. has shown to be more resilient than in Europe,” said David Rogal, portfolio manager at BlackRock. He added that this is partly because the United States has a relatively closed economy and high government spending.
He said Europe has “a more open economy that is sensitive to global manufacturing developments and has less fiscal impulses.”
Ratings agency Fitch expects the U.S. government's budget deficit (the difference between total spending and total revenue) to be 8.1% of gross domestic product this year, compared to 1.4% for Germany.
