Pressure in the European sovereign rates markets triggered a selloff in the U.S. bond market last week as Treasury Bonds traded lower in sympathy with German Bunds. Just a few weeks ago, German 10-year Bunds were yielding a mere 0.07%. Fast forward to today and 10-year Bunds are yielding 0.85%, a dramatic move higher in such a short period of time. The selloff in Europe has been driven by better than expected data on growth and inflation, and while both are still tepid, the slight improvement has led investors to believe that the ECB’s quantitative easing program is working. In addition, ECB President Mario Draghi said publically that the ECB is not concerned with market volatility, indicating that the central bank will not adjust its policies just because rates are rising.
For U.S. bond investors, we believe there are two main takeaways:
- Despite what the headlines may seem to suggest, 1- to 10-year U.S. bonds have hung in there. Through Friday, returns for our Core Intermediate Strategies are about flat on the year. Most of the severe price pressure has been on the long end of the yield curve, with the 30-year bond in particular underperforming YTD. Our intermediate strategies, which have significant exposure to bonds maturing within the next few years, have exhibited much lower volatility.
- There is more room for U.S. bonds to outperform German bonds. We showed the below chart in January as part of our 2015 fixed income outlook to illustrate the wide divergence in rates between the U.S. and Germany. When this spread tightens, which it has so far this year (1.90% to 1.54%), it means that U.S. bonds outperform. As shown in the graph, there is still significant room for German rates to rise without having an outsized negative impact on U.S. bonds.
10-year U.S. Treasury vs. 10-year German Bund Spread