(Bloomberg) -- Vanguard and Goldman Sachs Group Inc. are among the firms betting that German government bonds faring better than US Treasury debt is a theme that has further to go.
A proxy for the trend — the margin by which the US 10-year yield exceeds Germany’s — has increased to about 1.9 percentage point from this year’s low of about 1.5 percentage point in mid-September, when the Federal Reserve cut US interest rates by a bigger-than-anticipated half point. Since then, the US rate has climbed roughly 60 basis points to about 4.20%, while Germany’s is only around 20 basis points higher.
The motivating idea is that with the US labor market and consumers showing surprising resilience, the Fed is backing away from cutting interest rates further in short order. The European Central Bank remains on track to deliver additional rate cuts as its economy slows.
“We are positioning for US rates underperformance versus European rates outperformance,” said Roger Hallam, global head of rates at Vanguard, which manages nearly $10 trillion in assets. “We are looking at relative growth differentials between the US and Europe and see a relatively favorable outlook in the US compared to what looks like a softer macro outlook in Europe.”
Traders are pricing in about 136 basis points of rate cuts by the ECB by September 2025, and 122 basis points from the Fed.
“It’s a trade we still believe in,” said Hallam.
Hallam heads Vanguard’s actively-managed bond funds, though more than half of the company’s roughly $2.4 trillion in fixed-income assets are in passively-managed index funds.
Goldman Sachs bond strategists last week maintained a recommendation to position for German debt to outperform 10-year Treasuries. While views about the likely outcome of US presidential election on Nov. 5 “have been a contributing factor in the month-to-date selloff in US rates, ongoing strength in the fundamental picture has been the primary driver of the move in our view,” a team led by George Cole wrote on Oct. 18.
“Incoming macro and policy data continue to support divergence between the US and other rates markets, especially Europe,” they wrote.
Since Fed policymakers cut rates last month, September employment data were stronger than anticipated, and consumer inflation was stickier. This week, Dallas Fed President Lorie Logan and Kansas City Fed President Jeff Schmidt have said they favor a slow pace of reductions going forward.
The International Monetary Fund on Tuesday lifted its forecast for US economic growth while lowering its euro-zone estimate. For 2025, it expects 2.2% growth for the US and 1.2% in the euro area.
The ECB has already stepped up its pace of rate cuts as inflation in the 20-nation bloc recedes more quickly than anticipated. Investors are betting on quarter-point moves at the next five meetings and a deposit rate of 2% by mid-2025. Markets also imply a 45% chance of a half-point reduction in December.
Speaking Tuesday on the sidelines of the IMF and World Bank annual meetings, ECB president Christine Lagarde said the euro-zone inflation trend is “relatively reassuring” and that the direction of borrowing costs were clearly lower though the pace undecided.
Pacific Investment Management Co. also favors European government debt, economists at the firm said in a note Wednesday.
Mohamed El-Erian, a Bloomberg Opinion columnist who’s held top investment roles at Pimco and Harvard University’s endowment, also views European and UK bonds more favorably than US Treasuries.
“The market is pricing in the same amount of cuts from the ECB and the Fed,” El-Erian told Bloomberg Television last week. “I don’t think that’s what’s going to happen.”
--With assistance from Francine Lacqua.
(Adds comments from Pimco economists, updates rates throughout)
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