A Historic Drop in the Yield Spread
The U.S.-German 10-year bond yield spread, a key indicator of borrowing costs, has dropped 62 basis points (bps) since January, now standing at 158 bps. This marks the steepest quarterly decline since the 2008 financial crisis, excluding pandemic-related fluctuations.
This narrowing spread is driven by diverging interest rate policies and economic outlooks, impacting:
- Investment flows
- The euro/dollar exchange rate
- Trade balances and corporate profits
Germany’s Fiscal U-Turn vs. U.S. Economic Uncertainty
Germany’s recent approval of massive government spending has reversed decades of fiscal conservatism, pushing Bund yields higher. Meanwhile, in the U.S., economic data suggests a slowdown, prompting concerns over growth and a decline in Treasury yields.
U.S. Treasury Secretary Scott Bessent acknowledged these risks, while analysts note that consumers and businesses are wary of tariffs, layoffs, and economic uncertainty.
Could the Yield Spread Fall Below 100 bps?
Some analysts predict that the U.S.-German yield gap could drop below 100 bps, a level not seen consistently since 2013.
- ING’s Padhraic Garvey suggests a potential 75 bps spread, noting that a U.S. recession could push it even lower—possibly to the 30 bps range seen between 2000 and 2009.
- Barclays forecasts Bund yields could test 3% (up from 2.8%), depending on tariff developments, while U.S. 10-year Treasury yields hover around 4.37%.
Shifting Investment Towards Europe
With higher German yields, investors are increasingly drawn to European assets. The euro has gained 4% in the first quarter of 2024, marking its best quarterly performance since Q4 2023. Additionally, European stocks are outpacing their U.S. counterparts, recording their strongest first-quarter relative performance in a decade.
UBS strategist Reinout De Bock noted rising enthusiasm for Europe among U.S. investors, with some struggling to assess whether this shift is uniquely beneficial for Germany or extends across the eurozone.
Meanwhile, Aviva’s Vasileios Gkionakis suggests that nominal GDP growth could push Bund yields up to 3.5%, with a potential overshoot to 4%. However, higher government investment could stimulate economic growth and reinforce Germany’s reputation as a safe-haven for investors.
Looking Ahead
As fiscal policies in Germany and the U.S. continue to evolve, the narrowing bond yield spread will remain a key metric to watch. A sustained shift in investment from U.S. Treasuries to Bunds could reshape global financial flows, strengthening Europe’s position in global markets.