As higher growth and inflation, together with Federal Reserve interest-rate hikes, have pushed Treasury yields higher, commentators have pointed to a changing U.S. landscape.
Savers can now secure higher interest income; mortgage seekers face funding costs not seen for many years; investors can gain somewhat better portfolio diversification benefits by owning fixed-income securities; and for stock pickers, financials have benefited while home builders have been hit.
But in terms of systemic importance, these developments could pale in comparison to the effect of recent U.S. interest-rate moves on the paradigm for determining rates in the advanced world. There are growing indications of a potential reversal in causality in the relationship between U.S. and European financial conditions.
For quite a while, Europe’s ample liquidity has put downward pressure on U.S. rates overall and contributed to what had been a notable flattening of the yield curve for Treasuries, including a spread between two-year and 10-year bonds that even fell below 20 basis points. But now, European monetary conditions can no longer contain the overall rise in U.S. yields, and are being tightened by events across the Atlantic. This has implications not only for Europe, which hasn't yet adopted a sufficiently pro-growth approach, but also for the emerging world.
Over the last few weeks, yields on short-dated U.S. bonds have risen to levels not seen for many years. This has been accompanied by two other notable developments: This time, the yield curve has tended to steepen rather than flatten. And internationally, rather than just widen the yield differential between U.S. and benchmark German bonds to even more elevated levels (the spread for 10-year bonds topped 260 basis points at the end of last week), German yields have been pulled up more and, in the process, have broken some notable benchmarks (including an increase above minus 50 basis points for two-year securities).
This ongoing change in the yield regime makes sense because of a divergence between the U.S. and Europe that has become more multidimensional. For example:
- U.S. growth has accelerated, powered by both consumption and investment, while Europe has been facing stronger headwinds.
- Trade tensions, both direct and indirect, are less harmful to the U.S. because of its more diversified and entrepreneurial economy, which is also less open to trade compared with European nations.
- The U.S. is pursuing a significantly more expansionary fiscal policy.
- The Federal Reserve raised rates on Wednesday for the eighth time since December 2015, and the central bank could go beyond what markets expect.