Big investors are selling U.S. Treasuries and buying European bonds, betting that weaker inflation in Europe will allow the central bank to start cutting interest rates sooner than the Federal Reserve.
Asset managers at Pimco, JPMorgan Asset Management and T Rowe Price have all increased their exposure to European government bonds in recent weeks.
That has helped push the so-called spread, or gap, between benchmark 10-year borrowing costs in Germany and the U.S. to 2 percentage points, near its highest level since November.
“The path to rate cuts is clearer in Europe than in the U.S.,” said Bob Michele, chief investment officer and global head of fixed income at JPMorgan Asset Management. “It’s hard to find an economic reason for the Fed to cut rates.”
He added that he currently has a larger holding of European government bonds than usual and is “getting in.” [the] Direction” to acquire more.
The change comes at a time when the economies of the United States and Europe are beginning to drift apart. Weaker inflation and the weaker economy in Europe are fueling bets that the ECB will cut interest rates more sharply than the Fed this year.
Markets are currently pricing in three or four rate cuts from the ECB by the end of the year, compared to just two or three for the Fed.
There has been a sell-off in government bonds on both sides of the Atlantic this year, pushing up yields as investors scaled back their expectations of impending interest rate cuts.
However, the moves were larger in the US, where the benchmark government bond yield rose 0.5 percentage points to 4.4 percent. In comparison, the corresponding German federal bond rose by 0.3 percentage points to 2.4 percent.
Andrew Balls, chief investment officer of global fixed income at Pimco, said he favored European government bonds and U.K. government bonds over U.S. government bonds this year because there were “more signs of an inflation correction.”
Pimco, which manages $1.9 trillion in assets, cut its forecast by a quarter point from three to two Fed rate cuts this year after releasing a blockbuster jobs report on Friday.
Economists expect U.S. inflation data for March released on Wednesday to show an annual rise to 3.4 percent. The values for January and February are already above analysts' forecasts.
In contrast, inflation in the euro zone fell to 2.4 percent last month, below forecasts. This reinforces expectations that the ECB will cut interest rates by summer.
“We prefer to be underweight U.S. Treasuries in favor of euro zone bonds, including Bunds,” said Quentin Fitzsimmons, senior portfolio manager at T Rowe Price, which manages $1.4 trillion in assets globally.
He said his belief in an ECB interest rate cut in June was “strong”, while strong US data had led to the Fed “backing away from its previously clear desire to start cutting rates”.
Fitzsimmons said if the ECB started cutting interest rates faster than the Fed, the lower interest rates would reduce the cost of hedging euro zone bonds compared to U.S. Treasuries.
He said this would “potentially encourage more capital to support the idea of relative outperformance of Bunds compared to U.S. Treasuries.”
But some analysts warn that the euro could weaken significantly if the ECB gets too far ahead of the Fed in cutting interest rates, risking a renewed rise in inflation.
“There can only be so much divergence before it has a big impact on the currency,” said Mike Pond, head of global inflation research at Barclays. “It could be difficult for the ECB to cut as much as we expect unless the Fed also cuts.”
Nevertheless, the inflation outlook in Europe is currently more favorable than in the USA. The European Central Bank estimates that annual inflation in the euro zone will be 2.3 percent in 2024, with growth of 0.6 percent.
By comparison, the Fed forecasts that the core personal consumption expenditures index – the Federal Reserve's preferred indicator of inflation – will cool to 2.6 percent this year from the current 2.8 percent.
The US Federal Reserve estimates that growth will be 2.1 percent by the end of the year.
“Growth in the U.S. has proven more resilient than in Europe,” said David Rogal, portfolio manager at BlackRock. He added that this is partly because the US has a relatively closed economy and high government spending.
He said Europe had “a more open economy with greater sensitivity to global manufacturing developments and less fiscal stimulus.”
Ratings agency Fitch forecasts that the U.S. government's budget deficit, the difference between its total spending and revenue, will be 8.1 percent of gross domestic product this year, compared with 1.4 percent for Germany.
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