Treasury yields rose again following data revealing that the U.S. economy experienced a slower-than-expected growth of just 1.6% on an annualized basis in Q1. Additionally, a core measure of inflation – PCE – unexpectedly increased by 3.7% in Q1, thereby delaying anticipations of a rate cut. Fed Funds Futures now show a quarter-point cut by year-end as shown in the bar chart below.
Not long ago, Jerome Powell had suggested the U.S. central bank was still on track to lower its key interest rate three times this year if price increases continued to ease.
This announcement has been forgotten as inflation persists. The U.S. 10-year Treasury yield gained 4 basis points over the week to 4.66% from 4.62%. This is its highest level observed since October 2023 and the fifth consecutive week of increase. The yield on the 2-year Treasury is now standing at the 5% mark.
Divergence Between ECB and Fed
The latest PCE, a new unpleasant surprise for U.S. inflation, increases the market's consideration of a scenario of monetary policy divergence between the United States and the Eurozone. During her last monetary policy conference, ECB President Christine Lagarde paved the way for interest rate cuts in June if the new data available by then does not undermine the central bank's confidence in the disinflation process. While she did not commit to a monetary easing cycle, she did assert her independence from the Federal Reserve decisions, and therefore, markets maintain their expectations of more than three rate cuts in Europe by the end of the year. This contrasts with the new prospects emerging in the United States. Let's remember that Atlanta Fed President Raphael Bostic warned last week that the Fed could even hike interest rates if inflation remained sticky. This divergent view keeps the dollar index at its highest level of the year, above the 106 threshold, but does not prevent Treasury yields from rising in Europe.
The 10-year Bund yield gained 8 basis points to 2.58% from 2.50%. The 10-year OAT yield advanced too, up 5 basis points at 3.07% after topping 3.12% on Thursday before easing on Friday as Moody's and Fitch maintained France's sovereign rating at Aa2 and AA- respectively, with a stable outlook, against all expectations. However, France's public deficit expanded to 5.5% of GDP in 2023, exceeding the government's target of 4.9%. Moreover, with the debt stock reaching 110.6% of GDP, France holds the third-highest debt ratio in the European Union, following Greece and Italy. That's what forced France's Finance Ministry to recently correct almost all its over-optimistic macroeconomic forecasts and urgently find sources of savings.