Many investors believed that U.S. interest rates, which started the year at 3.02%, would move north this year and approach 3.50%. But in fact, the opposite has occurred and rates now sit at 2.50% as of August 4th. What happened? This year, Europe joined Japan with another aggressive attempt at further easing of monetary policy, which pushed interest rates lower across the Atlantic. German government bonds (Bunds) are now at an historic low yield of just over 1.15%. Even in troubled Spain, corresponding bond yields have moved below 2.30% to reach their lowest yield dating back 225 years to 1789! Although low, European yields are not the lowest in the developed world. Across the Pacific, Japanese government bonds (JGBs) have an astonishingly low yield of 0.50%. In an era of globalization and rapid money movement, it is hard to argue that current U.S. yields of 2.50% are unattractive compared to corresponding bonds overseas. The 135 basis point (bps) spread between Treasuries and Bunds is rapidly approaching record levels. In fact, the last two times the spread was this wide it soon reversed course leading to one of two results, higher Bund yields or lower Treasury yields. But which outcome is most likely? Let’s analyze each case.
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