As the Federal Reserve moves to end its debt purchases, U.S. bond-market bulls are discovering a new ally: European Central Bank President Mario Draghi.
For the first time since 2007, Treasuries (CBOT:ZNU14) offer higher yields than government debt in Europe. That’s largely due to Draghi, who pushed the region’s borrowing costs to record lows after announcing an unprecedented set of stimulus measures last month including negative interest rates to prevent deflation.
With Fed Chair Janet Yellen trying to extricate the central bank from more than five years of its own extraordinary monetary policies to support the world’s largest economy, the relative advantage may help attract more overseas investors to Treasuries and prolong their biggest advance in four years. At 2.48%, 10-year notes yield more than twice as much as German bunds, the biggest premium since 1999.
“It certainly does give the Fed some cover to pursue its agenda,” Tim Palmer, the Minneapolis-based head of global bonds at Nuveen Asset Management, which oversees $120 billion, said in a July 24 telephone interview. “It’s likely to be less disruptive to the extent that other countries are engaging in policies that add some liquidity.”
While forecasters foresaw higher yields at the start of the year as the U.S. economy gained momentum, investors poured into Treasuries as lackluster job growth and turmoil from Russia to the Middle East fueled demand for haven assets.
U.S. government debt gained 3.4% this year, the biggest year-to-date return since 2010, data compiled by Bank of America Corp. show. The MSCI World Index of equities in developed nations returned about 7%, while the Bloomberg Commodity Index of 22 raw materials advanced 2.9%.
Now, as the Fed shifts from buying bonds to debating how soon to raise interest rates, sustaining demand from foreigners who own almost half the $12.1 trillion of outstanding Treasuries has never been more important. Since 2008, the Fed has inundated the U.S. economy with more than $3 trillion of cheap cash with debt purchases aimed at suppressing borrowing costs and restoring demand crippled by the financial crisis.
A growing chorus of investors including Apollo Global Management LLC and hedge-fund manager Stan Druckenmiller are already warning the Fed’s easy money has created asset bubbles and unnecessary risks to the economy.
And as Yellen tries to determine how best to tighten monetary policy without upending the economy beset by slack in the labor market, Dallas Fed President Richard Fisher said in a July 16 speech in Los Angeles that the central bank is at risk of “overstaying our welcome by staying too loose, too long.”
In Europe, Draghi is pressing ahead with more stimulus as the ECB tries to combat the specter of deflation. On June 5, it cut the deposit rate to minus 0.1%, becoming the first major central bank to take one of its main rates negative.
The ECB also announced the central bank will start working on a quantitative-easing-style plan to purchase asset-backed debt and introduce a program to encourage banks to lend that may reach €1 trillion ($1.3 trillion).
While Draghi has struggled to weaken the common currency, the measures helped propel the biggest year-to-date returns for euro-area government debt since 1995, data compiled by Bank of America show. Bond yields are now so low the policy differences of the ECB and the Fed have given Treasuries an advantage.
Treasuries from two-year notes to 30-year bonds now yield an average of 1.54%, or 0.32 percentage point more than euro-area bonds. That’s the most since 2007. As recently as last year, U.S. debt yielded a percentage point less.