By Geoffrey Smith
Investing.com -- U.S. stock markets may have closed Thursday at new record highs, Europe’s are still to get back to their pre-pandemic levels, thanks to stricter lockdowns and a largely sluggish rollout to national vaccination campaigns.
But that may be set to change. A look at two bond yields shows why.
The first is the U.K. 2-Year Gilt, which is set to break above 0% for the first time in nearly three months, after the Bank of England - in a typically backhanded, passive-aggressive, British kind of way - more or less ruled out the possibility of negative interest rates.
The Bank said on Thursday that it would want to give the U.K. banking system six months to prepare for the change to negative rates, a timeframe that makes any such move impossible before August.
By then, however, even if one thinks negative rates would do any good (and plenty at the BoE obviously don’t), the need for them will largely have passed: the U.K. government projections suggest that every adult in the country will have been vaccinated by June and - assuming that the vaccines are also effective against newer strains of the Covid-19 virus - the economy will no longer be at risk of renewed shutdowns.
Against that background, the two-year Gilt yield started the week at -0.15%, and is on course to end it at -0.02%. The upward pull in bond yields worldwide stemming from the U.S. Treasury market may easily be enough to take it above zero by the close.
U.K. bank stocks have profited handsomely as the threat to their margins recedes: Natwest Group (NYSE:NWG) stock has risen 13.6% this week, Lloyds (LON:LLOY) stock has risen 12.5% and Barclays (LON:BARC) stock 11%. Other reopening plays have also prospered: pub groups J D Wetherspoon (LON:JDW) and Mitchells & Butlers (LON:MAB) have risen 12% and 14.6% respectively (M&B even had the confidence to reject a hefty premium bid from private equity at the start of the week), Restaurant Group (LON:RTN) stock has leaped 25% and SSP Group (LON:SSPG), which operates eateries and snack bars at the U.K.’s airports and train stations, has risen nearly 14%.
It’s a different story with the other important bond movement of the week. Italy’s 10-Year yield has fallen from 0.65% to as low as 0.51% in response to Mario Draghi’s return to Italian politics. Draghi has accepted the task of forming a new government after the collapse of Prime Minister Giuseppe Conte’s coalition. More importantly, the yield premium that Italy pays relative to Germany – a reliable indicator of market confidence in Italian stability - has fallen back under 1%.
That doesn’t change a thing about the long-term challenges that Italy faces (and many people in the market are overlooking Draghi’s poor record as a consensus-builder at the ECB and what that may mean for his ability to succeed politically), but it does remove a serious source of risk to the broader Eurozone economy in the near term. Italy’s banks, which are still more or less stuffed full of Italian government debt, have been almost alone in outperforming U.K. ones this week as a result. Results from Intesa Sanpaolo (OTC:ISNPY) later Friday, and Unicredit (MI:CRDI) next week, may well give extra impetus to that trend.