U.S. Fed Rate Hike Could Make European Bonds Spike
Watch your higher risk and higher yielding sovereign bond holdings this week, says S&P
Investors have been warned to watch their higher yielding government bond holdings this week as markets gear up to the much anticipated Federal Open Market Committee (FOMC) meeting tomorrow (17 September) when they will decide whether or not to raise U.S. interest rates.
Heather McArdle, S&P Dow Jones Indices’ director of fixed income indices, said at a press event Tuesday that European government bond yields could spike if the FOMC hikes rates.
“Because there’s been such low interest rates for years now, there’s been a strong demand for bonds with yield,” explained McArdle, a former bond trader at Citigroup. “So a rise in U.S. rates could cause a sell-off of the lower yielding government bond markets as investors opt for higher yielding and high quality bonds of the U.S. government, which could cause European markets to go down, increasing yields in the Eurozone.”
Furthermore, if investors then flock to U.S. government bonds, that will cause their yields to go down also, regardless of the rate hike, added McArdle.
McArdle said higher yielding bonds will be the first to sell off, like government debt from the peripheral countries like Italy, Spain and Portugal.
“Those are always the first countries to sell off – they have the most yield to move,” she said. “You’d be less concerned with Germany as it’s a flight to safety.”
During the last 24 month rate-hiking cycle in the U.S. which started on 30 June 2004, there was “virtually no effect” on European sovereign bonds, as shown by the S&P Eurozone Developed Sovereign Bond Index from 1 June to 29 July the same year.
But in the two days leading up to the FOMC’s meeting on 18 March 2015, sovereign bond yields in Italy, Spain and Portugal widened between eight and 12 basispoints, indicating a sell-off in these markets.
In the week leading up to this FOMC meeting, the S&P Spain and Portugal bond indexes widened out the most as of 11 September, by as much as 1.6 percent.
“These indices reaction is more muted than in March but still shows a similar pattern,” she said, adding that European government bond markets are more sensitive to Fed rate hikes than in the past.
McArdle warned that the Greek elections on 20 September could bring more volatility to European bonds.
McArdle’s comments follow Paul Jackson, managing director and head of research at ETF provider Source, revealing that out of the past 16 rate-hiking cycles since 1936, investors in 10-year U.S. Treasuries would only have lost money in four of those cycles.
