Sunday 25 February 2018

Jackson Hole: Italian, Spanish debt may shrug off any Fed rate hike

Janet Yellen, chair of the U.S. Federal Reserve
Janet Yellen, chair of the U.S. Federal Reserve

Any speculation about the timing of a Federal Reserve rate hike at this week's central bank forum at Jackson Hole could raise fears of a fall in demand for bonds in the euro zone periphery, but holders should be reassured by the weak correlation between Spanish and Italian bond yields and their U.S. counterparts.

The annual symposium of top central bankers in Wyoming, starting on Thursday, is always closely watched for clues about future policy. A speech by Federal Reserve Chair Janet Yellen on labour markets will be scoured for clues to when the Fed will raise interest rates - a move that will have global repercussions.

The Bank for International Settlements and others have warned that heavy buying of high-yielding, low-rated bonds in recent years may have created a bubble that could burst when money gets more expensive.

In the euro zone, where ultra-easy monetary policy has taken the sting out of a debt crisis, such worries are focused on Italy and Spain, the 'too-big-to-bail' countries whose borrowing costs have fallen sharply since 2012.

The market consensus is that a Fed rate hike will push U.S. yields higher, but will that drag euro zone yields up with it?

Historical correlations between the two markets show German debt has a significant sensitivity to moves in U.S. Treasuries, while Spanish and Italian bonds are largely untroubled.

The 100-day correlation between German and U.S. 10-year yields is a fairly strong 0.7 - where 1 is perfect correlation and 0 is none - and has hovered around this mark all year. In Spain and Italy, the correlation barely exists.

"If (U.S.) yields start to rise ... we can expect in an initial phase Bund yields to rise faster than peripheral ones," said Gianluca Ziglio, an analyst at Sunrise Brokers.

"So for every 50 basis points rise in U.S. yields you might see a 20-25 bps rise in German yields and only a 10-15 bps rise in Italian and Spanish yields at most."


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