The debt market has become tense after the Iranian attack on Israeli soil, but not all sales are a response to an escalation of geopolitical tension in the Middle East. In recent weeks, German bonds recorded an increase in yields lower than those of US bonds due to the expected divorce between the US Federal Reserve and the European Central Bank. With German debt at 2.4% and US debt above 4.6%, the risk premium between the two is at December 2019 highs.
The most recent blow to the fixed income market, particularly to sovereign debt issued across the Atlantic, was given by the US retail sales data (up 0.7% compared to the expected 0.4%, according to Bloomberg), which only confirms the delay in easing monetary policy in the country. However, the fact that US ten-year sovereign bonds offer higher interest rates than German bonds is not new, as investors have demanded higher returns for these securities in the secondary market since 2012 when the debt crisis ravaged Europe.
The difference between the two bonds has grown to almost 220 basis points because the Federal Reserve does not plan to cut interest rates as soon as expected in the eurozone. Federal Reserve Chair, Christine Lagarde, already argued that her institution does not depend on the US and is willing to begin cuts in June if inflation does not hinder it by that month’s meeting.
Since the beginning of April, US ten-year debt has increased by more than 25 basis points while German bonds of the same term remain in the same range, around 2.4%, although they have been 10 points above and below this yield this month. This puts the yield of the US reference at highs from last November while the bund has remained almost flat for the past two months.
This risk premium between sovereign debts (which is calculated by subtracting the yield of a bond issued by one government from another, expressed in basis points) also exists across other maturities. The 200 basis points are exceeded in the vast majority of the debt curve from two to 30 years (that is, in the securities, two, five, seven, 10, 20, and 30 years), although none of these premiums have reached records not seen in over four years, as is the case with the ten-year maturity, which is the market reference for long-term yields.
With the recent price drop in the sovereign bond market, all maturity tranches of less than two years yield over 5% also as a result of the March US CPI data, which showed greater resilience to price declines than expected by the market. “Our estimations about sticky inflation delaying rate cuts were correct. But we believe that this disappointment, which represents a reality check for the market, has completed or almost completed the adjustment of US bonds,” explained Bankinter. Indeed, from the bank’s analysis department, they would be considering that with the interest on the ten-year sovereign debt around 4.6%, there is not much higher upside risk.
What is clear is that few foresaw a spike of these magnitudes in sovereign debt yields at the beginning of the year, where the market consensus expected up to six interest rate cuts in the US compared to the three or even two projected now, according to Bloomberg. This translates into losses for the most conservative investor who focused solely on fixed income. For example, someone who focused their portfolio only on sovereign debt and bought at the beginning of the year would face a drop of over 4.6% to date, based on the Bloomberg government debt index. Only high yield as a category allows modest gains in 2024.
