At its October 2017 meeting, the European Central Bank (ECB) announced it would be making asset purchases at a monthly pace of €30 billion starting in January 2018, down from the prior pace of €60 billion, and continuing through the end of September 2018, or beyond, if necessary.
That meant the ECB would be soaking up less supply, which prompted assumptions that the bund rate would be moving higher.
Those assumptions, however, have been blown out of the water. The yield on the bund, which stood at 0.50% in front of the October meeting, has gone down, not up, since that meeting. It currently sits at a lowly 0.30%.
More to the Story
What's more is that the ECB had another policy meeting on December 14 and repeated the announcement that it will be curtailing its monthly asset purchases starting in January 2018.
Importantly, the ECB repeated that it stands ready to increase its asset purchase program if the outlook becomes less favorable; and it also declared that it expects key ECB interest rates to remain at their present levels for an extended period, and well past the horizon of net asset purchases.
The irony of that view is that it was shared at the same time the ECB increased its real GDP growth outlook for 2018 (from 1.8% to 2.3%) and 2019 (from 1.7% to 1.9%); and it came on the heels of a report showing the manufacturing PMI for the eurozone for December hit a record high 62.0.
In other words, economic conditions are improving in the eurozone, yet the ECB's ultra-low policy rates (0.00% for main refinancing operations; 0.25% for the marginal lending facility; and -0.40% for the deposit facility) haven't changed one bit and aren't expected to change anytime soon, according to the ECB.
That's a stunning divergence, yet it makes ample sense in the ECB's eyes because it is beholden to a single mandate of maintaining price stability, which the ECB pursues with the aim of maintaining inflation rates below, but close to, 2% over the medium term.
The latest year-over-year increase in the Harmonized Index of Consumer Prices for the euro area, which hit 2.0% in February, was 1.5%. GDP growth, then, has picked up, but the inflation rate has been decelerating.
Hence, the more things have changed for the euro area in terms of its economic growth rate, the more they have stayed the same in terms of the ECB's interest rate policy.
The persistence of those low policy rates has been the fuel for an interest-rate differential trade that has kept the 10-yr Treasury note yield under wraps despite the growth pickup in the U.S., which has also been accompanied by an inflation rate that has run persistently below the Federal Reserve's longer-run 2.0% target.
The Federal Reserve, however, has a dual mandate of maximum employment and price stability, and because of the gains in the labor market, it has moved on interest rates when the ECB hasn't.
Accordingly, European buyers -- and Japanese buyers for that matter, who are staring at a controlled 10-yr yield of 0.04% on the Japanese government bond -- are seeking higher yields elsewhere and they are seeing greener pastures (monetarily speaking) in the Treasury market.
What It All Means
The result has been a flattening of the Treasury yield curve, yet that hasn't diminished the appeal of the interest-rate trade.
To wit, the spread between the 10-yr Treasury note yield and the 10-yr bund yield stands at 207 basis points today versus 191 basis points in October when everything was still the same with the ECB's interest rate policy.