Bond Yields Jump as Defense Promises Ripple Around the World
1 / 3
Bond Yields Jump as Defense Promises Ripple Around the World
James Hirai
4 min read
(Bloomberg) -- Bond yields jumped on Monday as investors prepared for a surge in government borrowing to fund defense following weekend talks among European leaders on how to support Ukraine.
German debt led the selloff, taking the rate on the nation’s 30-year securities up 12 basis points, the most in almost a year, to hit 2.82%. US Treasuries also fell, with the 10-year yield up four basis points to 4.25% while defense stocks lift European indexes and the euro rallied.
The prospect of more European defense spending has been growing in recent weeks, and gained new urgency following a contentious meeting between US President Donald Trump and Ukraine’s Volodymyr Zelenskiy on Friday. Over the weekend, leaders from across the continent gathered in London to hammer out new pledges for military investment and recommit to Ukraine’s.
“There is no doubt that defense spending will increase significantly,” said Jens Peter Sorensen, chief analyst at Danske Bank. “There will be more issuance in the long end of the curve so investors want to have risk premium.”
The moves come after a robust bond rally in February that took Treasury yields to the lowest levels of the year. But with US tariffs on Canada and Mexico due to take effect this week after a month-long reprieve, and investors treading carefully ahead of US data including payrolls, yields risk moving higher again.
In Germany, the two parties likely to form the next government are exploring options for large-scale investments in defense and infrastructure. Officials are considering setting up two special funds for defense and infrastructure, potentially worth hundreds of billions of euros each, according to a Reuters report.
While an official in one of the parties said on Sunday he was unaware of the numbers mentioned in the report, the discussion is leading investors to contemplate a sizeable increase in spending that would mark a huge change for the nation’s fiscal stance. Germany has historically been prudent with public spending, which has left investors in the region craving for more of its triple-A bonds — even if at a higher risk premium.
“It would be a fiscal regime shift of historic proportions,” said Robin Winkler, chief German economist at Deutsche Bank AG, in a client note. “If reports over the weekend prove correct, the two funds would add up to a significant fiscal impulse.”
One pressure valve that is sensitive to changes in the supply of German debt — the bund swap spread — fell to a record low in data going back to 2007, reflecting the concern among investors who will be tasked with absorbing more sales.
Meanwhile, the euro surged as investors bet more government spending in the region will support growth and lead the European Central Bank to be more careful in cutting interest rates further. That view was supported by data on Monday showing euro-area inflation slowed less than expected in February.
The common currency rose as much as 0.8% to $1.0458 and was among the best performers among Group-of-10 currencies versus the dollar. Bond traders pared bets on further easing from the ECB, with swaps now implying 80 basis points of reductions on borrowing costs by the end of the year, from 87 basis points on Friday.
Germany’s benchmark stock index jumped as much as 1.2%, led by a surge in defense stocks and outperforming euro-area peers.
“Higher German/European defense spending has the potential to be transformational for the whole of Europe,” said Ales Koutny, head of international rates at Vanguard Asset Management Ltd. “This should lead to slightly higher yields across Europe, but significant strength and stability for the euro.”
What Bloomberg strategists say:
“With inflation still simmering away and European leaders contemplating spending for defense on a scale not seen in years, the steepening of the German yield curve will find little respite just yet.”
— Ven Ram, Cross-Assets Strategist, Dubai
The moves in European markets helped boost global risk appetite, which has been on the rise since late Friday amid US equity gains and an advance for crypto over the weekend. The next test to the market will come from the US tariffs scheduled to take effect Tuesday — even if delayed, any reprieve could prove temporary as a host of other Trump levies are due in April.
For some, the bond declines have been sufficient to induce covering of bets targeting higher yields. Mike Riddell, a portfolio manager at Fidelity International, said “a lot of the expected supply is now in the price.”
Yet others like Benoit Anne, a managing director at MFS Investment Management, think the path forward for yields is higher, both in Europe and the US — where he says yields have reached a bottom.
“There are good reasons why bond yields would go up and there are bad ones,” said Anne. “In the context of the euro zone, it is less about a tangible improvement in macro-conditions — the good reason — and more about the perception of higher fiscal risks in the face of higher government spending, especially when it comes to defense.”
--With assistance from Alice Atkins, Naomi Tajitsu and Nick Bartlett.
(Updates with additional context on US in paragraph five.)
