The world’s most-influential bond market might just be in Frankfurt.
As speculation deepens the European Central Bank will start quantitative easing just as the Federal Reserve ends its own bond buying, Europe is gaining more leverage over investors globally as the specter of deflation in the region unleashes greater demand for fixed income. The gravitational pull exerted by German bunds may blunt any jump in yields as the Fed moves to raise U.S. interest rates for the first time since 2006.
None other than Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., said on Aug. 20 the direction of 10-year German bunds sets the “tone” for investors. A day later, Citigroup Inc. cut its yield forecasts for U.S. Treasuries on weakening growth and inflation expectations in Europe after German yields fell below 1 percent.
“Developments in the euro area are causing long-term rates to be lower all over,” Amitabh Arora, the New York-based head of interest-rate strategy at Citigroup, one of 22 primary dealers that trade directly with the Fed, said in a telephone interview on Aug. 25.
Arora anticipates yields on 10-year Treasuries will end the year at 2.8 percent from 2.4 percent as of 9:55 a.m. in New York. He trimmed his call from 2.95 percent after the firm’s economics team predicted the ECB will start a 1 trillion-euro ($1.31 trillion) asset-purchase program by December to keep consumer prices from falling as the region’s economies sputter.
Bond yields across the euro area, from Germany to France and Spain, have tumbled to records since ECB President Mario Draghi said at the Kansas City Fed’s annual conference in Jackson Hole, Wyoming, Aug. 22 the central bank will use “all the available instruments needed to ensure price stability” and is “ready to adjust our policy stance further.”
Yields on the German 10-year bund fell to a record 0.866 percent on Aug. 28, while France’s benchmark rate reached 1.217 percent. Spain’s 10-year bond yields ended yesterday at 2.25 percent -- below those of comparable U.S. securities.
The growing influence of the ECB also means more investors are taking cues from the $1.5 trillion German debt market -- rather than the $12.2 trillion market for Treasuries -- to find out where bonds globally are headed.
As 10-year German yields fell below 1 percent last month for the first time, similar-maturity securities in the U.S., the U.K. and Canada were moving more in tandem with bunds than at any time this year, data compiled by Bloomberg show.
On the day the Fed released minutes of its July meeting, Gross, who runs the $223 billion Pimco Total Return Fund, said on Twitter that 10-year bunds set the “global market tone.”
Worsening economic conditions in Europe may now bolster the case for more stimulus when the ECB meets on Sept. 4, depressing yields further. The inflation rate in the 18-nation euro region fell to 0.3 percent in August, the lowest in five years, data from the European Union’s statistics office showed Aug 29.
As recently as January 2013, living expenses were rising faster than the ECB’s target rate of just under 2 percent.
Germany, Europe’s largest economy, shrank 0.2 percent in the second quarter, while France’s stagnated and Italy fell back into a recession, separate reports showed last month.
“The European financial system and economy is a huge portion of the developed world,” Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview on Aug. 26. The ECB “is a very powerful central bank that drives investment dollars.”