European bond traders are chasing the wrong lead

Uncool copycats. Trying to solve interest rate riddle, euro zone bond trers are looking at wrong clues. European Central Bank hinted on Thursday that it may lower borrowing costs in June. That would place it ahe of Federal Reserve. Yet fixed-income investors seem more preoccupied with strong U.S. inflation data. That will le m to wrong conclusion.

Christine Lagarde must worry about 20 different economies and doesn’t need anor one on her list, not even world’s largest. ECB president clearly stated on Thursday that developments in United States will not affect monetary policy in euro zone. So ECB remains rey to cut rates in June, barring any unexpected shocks, even as Fed may delay its own easing due to a fast-growing economy and robust inflation.

Bond investors, however, are not listening. y keep shunning bloc’s debt. Yields on Germany’s two-year bunds – a proxy for euro zone debt – rose from 2.96% to 2.97% on Thursday. That’s highest level since November 2023, after a big rise from 2.89% on Wednesday. reason for that yield jump? Strong inflation data in United States that put paid to market hopes of a Fed rate cut in June.

Euro zone bonds have been aping U.S. ones for a while. In February, correlation between German and U.S. two-year bond yields hit a record high, according to State Street analysts.

But strategy is misguided when two blocs’ economic realities are so different. Atlanta Fed estimates that U.S. GDP is growing at a 2.4% annual rate. euro zone expanded at a measly 0.1% annual pace in fourth quarter of last year. That’s reflected in respective inflation rates: 3.5% for United States and 2.4% in euro zone, getting closer to ECB’s 2% target.

It’s true that ECB has never initiated rate cuts before Fed, as Deutsche Bank analysts noted last week. But Lagarde’s job is to look at economic realities, not historical records. If she follows through on her hints, euro zone yields will start falling soon, pushing prices higher. On that basis, bloc’s bonds look a better bet than U.S. ones.

Foreign exchange trers get idea. y sent euro to a two-month low against dollar on Thursday. Bond trers should stop obsessing about what happens in Washington if y want to avoid a painful reality check.

Context News

European Central Bank kept interest rates at record highs on April 11 but sent a clear signal it may cut m in June as euro zone inflation continues to fall. central bank for 20 countries that share euro kept its deposit rate at 4.0%. But with inflation now close to ECB’s 2% target, bank lending at a standstill and economy barely growing, ECB dropped fresh hints about a possible cut at its next meeting.