German-U.S. yield gap stretches after ECB “wake-up call”

The gap between German and U.S. bond yields revisited multi-decade highs on Tuesday after European Central Bank policymakers helped curb a recent sell-off in the bloc’s debt by reaffirming their commitment to easy monetary policy.

Having risen sharply recently on expectations of higher global inflation emanating from fiscal expansion in the United States under President-elect Donald Trump, German 10-year yields fell 4 basis points to 0.24 percent on Tuesday.

That pushed the gap between them and U.S. equivalents to 206 basis points, wider than any previous market close since at least 1990 and very close to an intraday peak of 208 bps seen last week.

The rally across euro zone debt markets also pulled German two-year yields below -0.70 percent for the first time since September, and five-year yields below the ECB’s -0.40 percent deposit rate for first time in two weeks.

Two top ECB officials said on Monday that the ECB needs to continue supporting the euro zone economy to bolster its fragile inflation outlook, cementing expectations for an extension of the ECB’s bond-buying scheme next month.

“Some of the commentary that we have had from the ECB in the last few days, although not really new, is a wake-up call to the market that some of the repricing that we have had has gone too far,” said Anton Heese, head of European rates strategy at Morgan Stanley.

Having racked up four consecutive weeks of rises, their worst run in 18 months, German 10-year yields have clawed back 7 basis points so far this week.

On Tuesday, all euro zone equivalents were down 4-9 basis points – even Italy’s, which have been stung by concerns that the populist wave that swept Trump into power could carry over to a referendum in the country next month.

ECB President Mario Draghi told a European Parliament committee on Monday the ECB needed to maintain its current level of monetary support to bring inflation, currently running at 0.5 percent, back to its target of almost 2 percent.

The ECB will decide on Dec. 8 on whether and how to extend its 80 billion euros ($85 billion) of monthly bond purchases. Sources have told Reuters the programme is all but certain to continue beyond its current March deadline.

Speaking separately in Munich, ECB Executive Board member Benoit Coeure said the time to start winding down the ECB’s extraordinary policy accommodation had “not yet” come.

Europe’s loose policy approach is in stark contrast to that in the United States, where the Federal Reserve is expected to raise rates for only the second time in a decade next month.

Money markets are pricing in a 95 percent chance of such a rise at the Dec. 14 meeting, according to CME’s FedWatch tool.

“We don’t expect growth or inflation to surge, the ECB is expected to keep monetary policy accommodative for some time, so it makes sense for (euro zone) yields to pull back,” said Patrick Jacq, European rate strategist at BNP Paribas.

Reuters

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