Several weeks have passed since the banking crisis spurred volatility and uncertainty in the markets. Silicon Valley Bank went bankrupt, Credit Suisse has been taken over by UBS and the rollover to the other banks seems to be contained at least for now. In the aftermath of the crisis, bond yields both in the US and Eurozone plunged by more than 100 bps. Nowadays, they have given back about half of the drop as the economy is still not losing steam as expected.
Following the crisis, central banks’ rhetoric is more data-dependent and careful similar to the start of the tightening cycle. Both the Federal Reserve and ECB insisted on the separation of instruments that ensure the stability of the financial system and short-term interest rates that are used to curb inflation. As time passed, the market began to believe in the mentioned separation. As both central banks stated, further rate hikes are still possible as the backstop for financial institutions guarantees the security of the financial system.
Since the peak of uncertainty on the markets when bond yields bottomed both in the US (US 10-year Treasury at 3.25%, US 2-year Treasury at 3.55%) and Europe (Bund at 1.92%, Schatz at 2.10%), markets have sold bonds as the core inflation still runs higher than expected. Since then, the US 10-year Treasury rose to 3.61% and the US 2-year Treasury rose to 4.26%. Furthermore, in Europe Bund rose to 2.51% and Schatz to 2.97%. Simply calculating the difference they managed to return, implies that Bund and Schatz rose more in yield than their US bond equal-duration counterparts. Before SVB collapsed, the Bund yield reached a high of 2.77% and Schatz at 3.38%. Currently the former is just 26 bps off its highs and the latter 41 bps. Across the Atlantic, the 10-year Treasury is at 47 bps and the 2-year Treasury currently stands at 82bps off the highs. Taking into account all of the above, the spread between US 10Y and Bund yield narrowed by 30 bps since the start of the year. The explanation for that lies in the hawkishness of the European Central Bank as no major risks emerged in the Eurozone.
To conclude, over the past month, both 2-year and 10-year bonds erased part of the gains on both sides of the Atlantic. As described, US bonds outperform their European counterparts as the hawkishness of the European Central Bank is still ongoing. European Central Bank for now seems to have no imminent crises and further hikes are still on the table. To be exact, according to OIS, three more rate hikes are priced for the European Central Bank and just one more for the Fed this year. In my opinion, yields can hardly go much higher as inflation is falling in both the US and Eurozone. Also, in case of more hikes, yields might not stem higher as the market anticipates more rate cutting amid a higher risk of financial instability.
Source: Bloomberg, InterCapital