Many of us have our favorite economic and financial indicators. I’m referring to those indicators that don’t get a lot - if any - attention from the television channels geared toward finance and markets and yet can provide important insights. One of my favorites - the divergence between key US and German fixed-income benchmarks - is at a notable level.
More specifically, I’m talking about the difference between the yield on the 10-year US Treasury note and its counterpart in Germany (which also serves as a benchmark for much of Europe). In early trading Wednesday, this differential had risen to 200 basis points in favor of the US, a level only reached three times since the start of 2020. Moreover, and as shown in the chart below, it is now well above the low over the past three years of 90 basis points and just short of the high of 214 basis points.
Two major developments have driven the recent widening. One is that US economic data overall has been stronger than consensus forecasts. The other is lower-than-expected euro zone inflation data.
Fundamentally, the widening captures the dominance of American economic exceptionalism over European economic stagnation, illustrated most comprehensively by the contrast between 4% growth in US gross domestic product in the second half of 2024 and recession in Germany. With that comes a divergence in inflation rates, with US price increases proving more stubborn than Europe’s in what many view as the “last mile” in central banks’ battle against inflation.
Importantly, there is more to this divergence than just recent economic numbers. The US economy is on a healthier endogenous growth path compared with Europe.
In addition to being supported by a more favorable set of initial conditions – from greater flexibility in factors of production to more agile entrepreneurship – US growth also has been boosted by a bigger fiscal impetus and stronger policy focus on the drivers of future economic growth. Also, as noted recently by Andrew Balls, the Pacific Investment Management Co.’s chief investment officer for global fixed income, in an interview with Bloomberg News, the structure of the US mortgage finance system makes its economy less sensitive to higher interest rates.
