Ten-year US Treasuries traded through the psychological 3% level again this week. This time, it is more convincing and US Treasuries continued to rise above 3.1%.
The US economy seems to have picked up pace again at the start of the second quarter. In Europe, though, these signs are still missing. Recent core inflation numbers have come in soft, especially in Europe. However, trade tensions and the US withdrawal from the Iran deal are pushing up oil prices, sending tightening signals for policy makers. Overall, a sustained and sharp rise in yields still seems unlikely, as we expect the US Federal Reserve to finish raising rates in the middle of next year at 3%.
We do not expect significant actions soon from the European Central Bank (ECB), as long as economic data remain disappointing. The recent widening of peripheral spreads will also keep the ECB cautious. Italian populists from Lega Nord and M5S have come close to forming a new Italian government that would plan a 15% tax rate, a guaranteed income for everyone and a reduction of the pension age. Spreads widened further to pre-election levels, on rumours that a plan to write off Italian government bonds on the ECB balance sheet was considered at some point during the negotiations. Although such plans do not stand a chance, Italian politicians would be wise to kill such stories immediately before they do even more damage. We have adjusted our spread target for Italy versus Germany to 160 basis points (bp) for 10-year bonds at the end of this year. However, the additional yield on Italian bonds is enough to absorb 20 to 30 bp of spread widening over a year and still beat German Bunds.
Meanwhile, spreads on emerging market debt widened on the combination of a stronger US dollar, geopolitical tensions and specific issues in various emerging market countries. This may not be over yet, but seems more like a buying opportunity building than a structural development, as fundamentals remain strong.