The Curious Case of Converging Yield Curves

The gap between two- and 10-year yields in the U.S. and Germany has converged

By Richard Barley

From one perspective, U.S. and European bond markets have diverged massively: the 10-year Treasury yield stands at 2.35% while 10-year German bonds yield just 0.39%. The Federal Reserve is raising rates; the European Central Bank is still deep in emergency-policy territory.

But from the perspective of the yield curve, the two sides are closer than you might expect.

The yield curve can help provide a window into the economic outlook. Yields on two-year debt tend to be affected most directly by central-bank actions, while 10-year yields paint a picture of longer-term expectations about growth and inflation. A steepening curve can be read as a sign of brighter economic prospects, and was one of the key signals last year that the market was embracing reflation.

A flatter curve could signal economic concerns.

Since the start of the year, the gap between two- and 10-year yields in the U.S. and Germany has converged, strategists at ING note, with both measures now just over 1 percentage point. That is unusual: the U.S. curve has been persistently steeper than its German peer since 2013.

But now the sands are shifting. The U.S. yield curve steepened sharply in the wake of President Donald Trump’s election victory but is now back close to levels seen before the vote, in part reflecting disappointing economic data. The German curve, by contrast, is still some 0.3 percentage point steeper than it was before the U.S. elections; it steepened again Thursday in response to another strong eurozone purchasing managers index Reading.

The factors behind the curves are different. In the U.S., the yield curve seems likely to respond most to Mr. Trump’s policy actions, and whether they are less underwhelming for investors than in his first 100 days. In Europe, it is economic data and monetary policy that are the bigger forces, with markets focused on even tiny shifts in the ECB’s dedication to ultraloose policy.

It is only one indicator of course. But the yield curve moves are another sign that it is Europe, not the U.S., with the stronger economic winds at its back.

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