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Draghi's bond buying plans ripple across Atlantic: Euro Credit

Published Fri, Feb 6, 2015 · 12:31 AM
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[LONDON] Even the world's biggest bond market is getting a boost from the European Central Bank.

President Mario Draghi's plan to buy government debt is suppressing rates in the euro region and boosting the appeal of higher-yielding US bonds. That's driving down yields on Treasuries, defying prospects of higher interest rates from policy makers closer to home at the Federal Reserve.

"In 25 years as a fund manager I have never been so bullish on US Treasuries," said Eric Vanraes, who helps oversee about US$2 billion at EI Sturdza Investment Funds in Geneva. "Other fund managers say you are crazy just before the central bank is at the start of a more hawkish view. But markets don't work like that. You have central banks being more and more accommodative around the world." Far from leading market trends across the world, the US$12.5 trillion Treasury market has been influenced from across the Atlantic as the ECB turns to so-called quantitative easing to revive the European economy just as the Fed ended stimulus.

US 30-year bond yields fell to a record 2.219 per cent on Jan 30, about 0.3 percentage point less than at the height of the financial crisis in 2008.

Thanks to ECB Futures trading showing a more than 50 per cent chance of US rates rising in 2015 hasn't stopped yields reaching levels that Fed Bank of St. Louis President James Bullard described as "astonishingly low." In a speech in Newark, Delaware, on Feb 3, he cited the 10-year Treasury yield at below 2 per cent.

"That's because it's a global market," he said. "This is a decline in longer-term yields that doesn't really have much to do with the fundamental factors in the US economy. It is coming to us courtesy of the ECB." The latest monthly ECB data show that euro region residents purchased 36 billion euros (US$41 billion) of foreign debt securities in November, taking the three-month total to 110 billion euros. Darren Williams, senior European economist at AllianceBernstein in London, said in a report last month it was the strongest outflow since the financial crisis struck and he expected the trend to continue because of quantitative easing.

Treasuries with a maturity of more than 10 years have gained 1.2 per cent since the ECB announced its plan to buy government debt, according to data compiled by Bloomberg.

Even after their drop, US 30-year government bond yields are still 1.45 percentage points more than that of similar debt in Germany, the widest spread based on closing prices since Bloomberg started tracking the data in 1994.

Geneva-based Vanraes said his firm is betting that longer- dated Treasury bonds will outperform securities with shorter maturities, leading to a flattening of the so-called yield curve. Ten-year yields may drop to as low as 1 per cent, while those on 30-year bonds could reach 1.5 per cent, compared with 2.39 per cent yesterday.

"You have global core bond yields moving lower which is making the US long end look relatively cheap," said Jabaz Mathai, head of US interest rate strategy at Citigroup Inc. in New York. "On top of low inflation risk that's also driving the long end lower, ECB QE purchases reduce the available supply of debt and this is supportive for the US bonds."

Eighteen European countries had 10-year government bond yields lower than the Treasury's yield at the end of last week, according to data compiled by Bloomberg.

Switzerland, which doesn't use the euro, has 10-year yields that turned negative on Jan 16, meaning investors pay to have their money invested in the country.

Yields across the continent have fallen as the ECB prepares to begin its bond-purchase program. German two-year note yields were negative 0.194 percent on Thursday compared with the ECB's deposit rate of minus 0.2 per cent.

Tumbling yields on German debt, the euro area's benchmark sovereign securities, came as the nation's inflation rate turned negative last month for the first time in more than five years, meaning consumer prices are falling as activity stalls.

The rate on German 10-year bunds fell to a record 0.297 per cent on Feb 2, lower than Japan's rate, which was 0.347 per cent on Thursday. Japan has experienced four recessions during the past seven years.

A driver for US rates has been speculation and the eventual announcement of the ECB's quantitative-easing program, which is similar to what the Fed completed last year. Previous ECB measures included cheap loans to banks, buying assets including covered bonds and the introduction of a fee to park excess cash with the central bank.

"US yield spreads are relatively wide versus those in Germany and are pretty attractive for relative-value investors," Tony Bedikian, Boston-based head of global markets at Citizens Commercial Banking, a division of Citizens Financial Group Inc., said in a phone interview. "Investors are buying into a currency in the US where we have relatively mild inflation but pretty significant job growth. It's a little bit of a Goldilocks scenario and that type of economy attracts capital, which seems to be the case here."


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