10-year U.S. Treasury-German bund yields spread widest since 1990

The Eurozone inflationary signals were strengthened by the recovery in energy prices and other commodities in the last quarter of 2016, but were surged off by the debt market. On the other contrary, Donald Trump’s US presidential victory on November 8 has altered investor expectations quite dramatically, including a change in sentiment across European debt markets.

Moreover, it is worth noting that the ongoing sell-off in U.S. Government bonds is mainly because of Donald Trump’s fiscal spending appeal, which is expected to be financed from government borrowing and not because of growth in U.S. economy.

If Trump successfully implements his fiscal plan, consumer inflation will surely rise, giving the Federal Reserve wider space for an interest rate hike. Thereby, rising Fed fund rate will increase the cost of borrowing. Also, increase in government debt will raise the risk of potential default. After the Presidential election result, Treasuries witnessed a massive sell-off, sending the 10-year yields higher by 80 basis points in just a month’s time. The benchmark United States 10-year Treasury yields jumped to 2.62 percent, hitting highest since September 2014. Thereby, we foresee that next year the 10-year yields will likely break 3 percent mark, the highest level in three years.

While 10-year Treasury yields rose from a low of 1.36 percent in the middle of the year to 2.60 percent by December, 10-year bund yields increased by more than 50 basis points from a low of -0.25 percent to about 0.45 percent during November and December. By mid-December the 10-year Treasury–bund spread widened to about 230 basis points, reported Lazard, an assets management firm in its research note.

Meanwhile, the ECB has had to contend with the Brexit decision in June, in addition to Trump’s unexpected election victory in November and the associated uncertainty surrounding inflation and US central bank policy. Confirmation of the ECB’s decision to extend its bond-buying programme (and discussed in more detail in the previous section) is viewed as necessary by a broad range of market participants, as QE appears to have reached its natural limits, since collateral has become scarce in the secondary market, they added.

As a result, the short end of the euro zone yield curve remains well anchored, while the long end has steepened in the wake of rising bond yields in the United States.