The Eurozone economy will shrink about 0.5% this year, and grow only 1% at best next year. Inflation will average 0.4% this year and 1.6% in 2014, according to Bloomberg data. Far worse than the economic circumstances in the US, where GDP is expected to grow 1.8% this year and 2.7% in the next. Inflation rates are expected to average 1.5% in 2013 and 2.0% in 2014. Furthermore, the ECB looks ready to ease if necessary, while the Fed will enter a ‘less-easing-mode’.
Two different stories, asking for different bond yields, right? Right, and yet the room for any more spread widening seems limited. First of all, ever since the mid 1990s, the correlation between changes in the US and German interest rate has been pretty strong, averaging approximately +0.75. Since last October the correlation has been consistently above +0.8, high by any standard. Now, a strong correlation does not necessarily mean that the interest rate spread can’t widen, but for anyone who is looking for European interest to go down while US rates are going up, this hardly ever happens.
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Second, the interest rate spread between the 10-year bonds yield in the US and Germany is already relatively large from a historical perspective. The differential is now close to 1%, a level that has not been crossed that often. Still, there could be some further widening, in 1999 the spread climbed to almost 1.70%, but taking the historical data into consideration, there is not that much space left. So, although the economic perspectives of the US and Europe look very different now, the chance of opposite movements in bond yields is slim.