Pioneer Group and Goldman Sachs Group, among other institutions, believe that the outperformance of German government bonds over U.S. Treasury bonds is a theme for the future. Reflecting this trend, the spread between the U.S. 10-year Treasury yield and the German 10-year bund yield has risen from a low of about 1.5 percentage points in mid-September to about 1.9 percentage points, following the Federal Reserve's unexpected 50 basis point cut in U.S. rates in September. Since then, U.S. rates have climbed about 60 basis points to around 4.20%, while German rates have only risen about 20 basis points.
The motivation behind these institutional views is that with the U.S. labor market and consumer showing surprising resilience, the Federal Reserve will not cut rates further in the short term, while the European Central Bank will continue to cut rates as economic growth slows.
Roger Hallam, global head of rates at Pioneer Group, which manages nearly $10 trillion in assets, said: "Our investment strategy leans towards poor U.S. rates and excellent European rates." "We are looking at the relative growth differentials between the U.S. and Europe and believe that the U.S. outlook is relatively favorable, while the European macro outlook appears weaker."
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Traders expect the European Central Bank to cut rates by about 135 basis points by September 2025, while the Federal Reserve will cut rates by 125 basis points.
Hallam, head of Pioneer Group's actively managed bond fund, said: "We still believe this is a trade," although more than half of the company's $2.4 trillion in fixed income assets are passively managed index funds.
Goldman Sachs bond strategists last week maintained their previous recommendation that German bunds will outperform 10-year U.S. Treasury bonds. They wrote: "Upcoming macro and policy data continue to support divergence between the U.S. and other rate markets (especially Europe)."
Since the Federal Reserve cut rates last month, U.S. employment data for September have been stronger than expected, and consumer inflation is more sticky. This week, both Dallas Fed President Lorie Logan and Kansas City Fed President Jeff Schmidt have indicated that they prefer to slow the pace of rate cuts in the future.
The International Monetary Fund raised its expectations for U.S. economic growth on Tuesday, while lowering its expectations for the eurozone. The organization expects the U.S. economy to grow by 2.2% by 2025, and the eurozone economy to grow by 1.2%.
Due to the faster-than-expected decline in inflation among the European G20 countries, the European Central Bank has accelerated its rate cuts. Investors are betting on a 25 basis point rate cut at each of the next five meetings, with the deposit rate reaching 2% by mid-2025. The market also implies a 45% chance of a 50 basis point rate cut in December.
European Central Bank President Lagarde said on Tuesday, on the sidelines of the International Monetary Fund and World Bank annual meetings, that the eurozone's inflation trend is "relatively reassuring," and the direction of borrowing costs is clearly downward, although the pace is yet to be determined.Mohamed El-Erian, former CEO of Pacific Investment Management Company (PIMCO), has stated that he also has a more favorable view of European and UK bonds over US Treasury bonds. El-Erian said last week: "The market expects the European Central Bank and the Federal Reserve to cut interest rates by the same amount." "I don't think that will happen."