Treasuries' Premium Over Bunds Jumps Before ECB as Fed Odds Rise

  • U.S. yield spread over Germany widens to 1.7 percentage points
  • Oil rebound has fanned speculation Fed can raise rates in 2016

The yield premium offered by Treasury notes over German sovereign debt swung to the highest this month as a rebound in oil this week bolstered bets the Federal Reserve will raise interest rates this year.

The spread between the benchmark U.S. 10-year note yield and that of equivalent bunds widened to as much as 1.7 percentage points Wednesday, the most since March 29, amid speculation European Central Bank President Mario Draghi will signal the potential for further easing when policy makers gather Thursday. The probability implied by fed funds futures of tighter U.S. policy this year has jumped to 62 percent from 49 percent at the start of this week.

“Oil is heading upwards,” said Daniel Lenz, lead market strategist at DZ Bank AG in Frankfurt. “The U.S. economy is in a mixed situation but it’s not doing too badly” so there is a chance “for the Fed to continue with rate hikes this year. In Europe, it is still the case that there is this expectation that the ECB is willing to add extra measures like a deposit-rate cut if needed. That’s why both markets move in the opposite directions.”

The benchmark Treasury 10-year note yield was little changed at 1.86 percent as of 6:43 a.m. New York time, after a surge on Wednesday of six basis points, or 0.06 percentage point, the biggest increase since March 1. The price of the 1.625 percent security due in February 2026 was 97 39/32.

Inflation Outlook

Oil trading at the highest level in almost five months has fanned inflation expectations. The 10-year break-even rate was little changed at 1.63 percentage points Thursday. The rate, which measures the difference between yields on 10-year notes and similar-maturity Treasury Inflation Protected Securities, is a gauge of trader expectations for consumer prices over the life of the debt. It has climbed from about 1.2 percentage points in February, the lowest since March 2009, based on closing levels.

“Because the oil price is rebounding, the Fed may raise rates as soon as June,” supporting U.S. yields, said Kazuaki Oh’E, the head of fixed income at CIBC World Markets Japan Inc. in Tokyo. “Maybe, just maybe, Draghi will put some more money into the market” as soon as Thursday, depressing bund yields, he said.

The near-term target for Treasury 10-year yields is 2 percent, a level not seen since March 16, Oh’E said.

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