Treasuries Look Dirt Cheap to Germans Buying Bunds

A word of caution to all bond investors who’ve been betting on a rapid rise in U.S. rates: Shrinking European debt yields make that scenario look less and less plausible.

While the Federal Reserve may be planning how to pull the plug on its unprecedented stimulus, the European Central Bank is just getting going. Let’s not forget policy makers in China and Japan, who are also trying to ignite growth by making it cheaper to borrow.

This all leads to a race to the bottom for rates and makes U.S. government debt look relatively cheap, even though yields are 1.18 percentage points below the decade-long average.

The benchmark 10-year Treasury note yields are about 1.38 percentage points higher than those on similar-maturity German bunds, about the biggest gap since 1999. That compares with the U.S. debt yielding 0.9 percentage point less than bunds back in December 2008.

Furthermore, U.S. bonds now yield just 0.2 percentage point less than debt of Spain, which has a 25 percent unemployment rate. Over the past decade, Spanish debt yielded 1.06 percentage points more than Treasuries on average.

The ECB’s extraordinary stimulus measures -- and preparations for more -- have investors plowing cash into European sovereign debt as growth in the region flags. Meanwhile, in the U.S., there’s still speculation that yields will go up, with Wall Street analysts surveyed by Bloomberg forecasting 10-year yields will increase to 3.08 percent by year-end from 2.43 percent today. Ten-year bunds pay 1.05 percent.

Rate Pressures

“Moderate economic growth in the U.S. and anemic growth overseas are not the type of fundamentals that generate significant cyclical interest rate pressures,” Jim Kochan, chief fixed-income strategist at Wells Fargo Funds Management LLC, wrote in a note this month.

Stable government and high-grade bond yields are “responding to fundamentals that still suggest a considerable period of low interest rates,” he wrote.

Even though yields aren’t really budging, some investors remain nervous that it’s about to become a bear market for bonds. They’ve sought out notes that are less sensitive to rising rates, funneling more than $8.8 billion into U.S. exchange-traded funds that focus on short-term debt this year, which increased their holdings by about 9 percent, according to data compiled by Bloomberg.

They’ve moved $1.2 billion this year into the ProShares UltraShort 20+ Year Treasury ETF, which acts as an amplified bearish wager on long-term bonds, undeterred by the third-worst performance among all U.S. fixed income ETFs.

They may be missing out on returns as geopolitical unrest and central bank stimulus keeps pushing investors yields lower. Treasuries don’t look so skimpy compared with what else is available overseas, and that may put a cap on how much they can actually rise -- no matter what the Fed does.

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