• Ten-year bunds set for first monthly gain since February
  • U.S.-German 10-year yield spread reaches two-month high

A selloff in German government bonds has proved short-lived, with benchmark 10-year securities set for their first monthly gain since February, even as the Federal Reserve has adopted a more hawkish tone on the outlook for U.S. interest rates. Data next week will go a long way to showing why the divergence trade is far from finished.

While gauges investors expectations for future consumer-price growth have been rising, data due May 31 are forecast by economists to show that the euro-area annual inflation rate dropped for a fourth month in May. That may prompt European Central Bank President Mario Draghi to re-emphasize that officials remain ready to expand stimulus if needed when they announce their latest policy decision on June 2.

The extra yield, or spread, that investors get for holding Treasury 10-year notes instead of similar-maturity German bunds reached a two-month high this week as investors pushed up wagers on the Fed increasing U.S. interest rates this year.

While Fed speakers have been preparing investors for the possibility of a rate increase as early as next month, euro-region bonds remain supported as the ECB implements its asset-purchase program. ECB officials will keep rates unchanged next week, according to economists surveyed by Bloomberg. A dovish tone from Draghi may mean there’s little prospect that debt securities follow their trajectory from 2015, when yields surged more than 1 percentage point from a record low in less than two months.

‘Limited Reaction’

“When you toss in the Fed sounding more hawkish these days as well as the limited reaction to bunds to the selloff in Treasuries, you could perhaps start to see bund yields drifting higher,” said Richard Kelly, head of global strategy at Toronto Dominion Bank in London. “But this is not going to be something like the tantrum risk last year. Yields will remain low.”

Benchmark German 10-year bund yields fell three basis points, or 0.03 percentage point, this week to 0.14 percent as of the 5 p.m. close in London Friday, leaving them 13 basis points lower since the end of April. The 0.5 percent security due in February 2026 rose 0.255, or 2.55 euros per 1,000-euro ($1,114) face amount this week, to 103.49.

Yields on Treasury 10-year notes were little changed on the week at 1.84 percent. The yield spread to bunds widened to 171 basis points on May 25, the most on a closing-price basis since March 25.

Euro-area sovereign securities returned 1 percent this month through May 26, compared with a less-than 0.1 percent gain in Treasuries, according to Bloomberg World Bond Indexes.

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