Just a month ago, it spread between BTp and Bund at 10 years it was close to 115 basis points or 1.15%, the lowest level since the autumn of 2021. This week, it rose above 140 points, although it subsequently fell below this threshold. Over the same period of time, the euro-dollar exchange rate fell from above 1.09 to a low of 1.06. And, as we will see, the two graphs are closely related to each other.
BTp Bund spread up with rebound in Italian ten-year yields
In absolute value, Italian ten-year yields rebounded from 3.70% to 3.90% in one month.
This is not good news for the Treasury, because it means incurring more interest expense as it issues new public debt securities. Germany’s Bunds also lost steam. On the ten-year stretch they are now above 2.50%, while in March they had fallen below 2.30%. All of this has to do with expectations on interest rates, revised upwards for the short term compared to the forecasts of recent months.
US inflation still high
The spread between BTp and Bund has widened, although remaining at decidedly reassuring levels, due to what is happening, in particular, across the Atlantic. L’inflation in the United States not only does it remain well above the 2% target, but it continued to accelerate in March. The governor of the Federal Reserve, Jerome Powell, explained that a rate cut it will not be there until it comes down. And the market is now discounting that it will no longer happen in June, but in September.
As a result, the 10-year T-bond now offers 4.60% versus 4.30% a month ago. At the end of December, it had fallen below 3.80%. Analysts see a race towards 5%. It is not even excluded that the Fed will be forced to raise rates once again to “cool” inflation expectations.
And these are precisely playing a decisive role on the bond market. The so-called “breakeven inflation“ at 10 years in the States it travels around 2.40%. This is the difference between the yield of ten-year T-bonds with a fixed coupon and that of TIPS, i.e. linked to inflation.
ECB rate cut in June
Therefore, the market is still pricing in long-term inflation well above the 2% target. And in the Eurozone? Going to check on the German market, we find that the Bundei at 9 years, i.e. the bond indexed to Eurostat inflation, offers 0.40% versus 2.45% for the same maturity with a fixed coupon. It follows that inflation in the area is expected to be around 2%, coinciding with the target set by the European Central Bank (ECB). Therefore, Atlanta is not in a position to cut rates yet, Frankfurt is.
Capital is heading to the United States precisely because of this expectation. T-bond yields are higher than those of the Eurozone along the curve, not just in nominal terms. In fact, the 10-year US bond currently offers a real yield of 2.20% versus just 0.40% in Germany. While inflation in the world’s largest economy will likely be higher than Europe’s, higher bond yields would more than offset it. Hence the appreciation of the dollar against the euro.
Spread BTp Bund effect of the wait on rates
The ones paying the price, as we were saying, are Italian government bonds. The widening of the spread between BTp and Bund signals that capital is looking for safer assets, given that monetary easing is receding globally. True, the ECB will most likely cut rates in June, but the pace in the following months may be slow. An excessive divergence from the Fed’s monetary policy would not be sustainable.
The single currency would collapse towards or below parity, triggering a new one inflationary spiral. But if rates stay higher for longer, less solid debts appear a little less sustainable. And the market demands a higher extra return to buy the securities. Here everything is explained.
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Tags: spread BTp Bund risen dollar continues strengthen euro
