(Bloomberg) -- Investors in the $13-trillion high-grade corporate bond market are zooming in on an unprecedented divergence between expected US and European monetary policy paths.
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European corporate bond returns are likely to outperform US peers as the region’s central bank is still expected to deliver several rate cuts this year, while the Federal Reserve is seen holding rates higher-for-longer, according to some money managers.
“You would expect euro credit total returns to be better if the current path of expected rates remains unchanged,” said Mark Benstead, senior portfolio manager at Legal & General Investment Management. And as spreads in the euro market are not as close to their historically tightest levels as US dollars or sterling, “there is more protection for euro too, arguably,” he said.
This type of disconnect so early in the year hasn’t been seen in all the time that Bloomberg has tracked rate expectations involving the Fed, the European Central Bank and the Bank of England. The only other notable early-year divergence was recorded in 2023, when traders were pricing in rate hikes — a backdrop typically associated with price drops in bonds — instead of cuts.
The divergence in rate expectations also comes as investors have few options to boost returns. Corporate bonds make money for holders through the coupon income and any price gains, which are achieved when spreads tighten, or when comparable government bond yields fall, pushing the overall corporate yield down.
But after a period of high inflows into the asset class, spreads are already ultra-tight, reducing the opportunity to make money by betting on even thinner risk premiums.
Borrowers have flooded the global debt market at an unprecedented pace, targeting deep-pocketed portfolio managers who have cash to spend after relentless fund inflows since last summer. In a sign of demand for new debt in general, the European Union saw above €170 billion ($174 billion) of orders for two bond tranches on Tuesday, while Greece attracted more than €31 billion.
Rate traders expect the ECB to cut rates by 25-basis-point increments more than three times by the end of 2025, even after they’ve softened their forecasts in recent days. By contrast, they’re barely pricing in a single Fed cut after Friday’s jobs data showed that the US labor market is hot.
And European policymakers are willing to take their own path. ECB Governing Council member Olli Rehn told Bloomberg TV on Monday that the bank should keep cutting rates, regardless of what the Fed does. He quipped that the ECB “is not the 13th Federal District of the Federal Reserve system.”