ECB-Fed Divergence Opens Window for Non-US Bonds

The European Central Bank's June rate hike, the first since September 2023, has opened a gap with a Federal Reserve that has not raised rates since July. That divergence, several fixed-income strategists said, makes government bonds outside the United States more attractive than US Treasuries right now.

George Bory, chief investment strategist in fixed income at Allspring Global Investments, is pushing clients toward countries whose central banks are still tightening. "Bond markets everywhere have rushed to price inflation," he told CNBC this week. "Places like the UK, certainly across Europe, even places like Australia – we've seen a material run-up in central bank tightening expectations." The ECB moved 25 basis points to 2.25% on June 11. The Bank of England and the Reserve Bank of Australia have also raised rates.

Bory recommends short-to-intermediate duration government bonds from developed markets outside the US. Central banks tethered to inflation will keep hiking, he argues. Rising policy rates push short-dated yields higher, giving bond buyers a bigger coupon and a reinvestment advantage. "Adding that international duration and mixing it with some US duration – now we're playing different rate cycles," he said. "That works really nicely."

Steve Laipply, global co-head of iShares Fixed Income ETFs at BlackRock, made a similar point. Fixed-income securities issued in Europe offer lower risk and higher yields relative to US paper, he said. Many bond investors are too US-centric, Bory added. The global bond market is massive. Diversifying duration, credit risk, and security selection can improve outcomes.

The CME Group's FedWatch tool, run by CME Group Inc. (Alpha Score 45, Mixed, sector Financials), shows a 78% chance the Fed hikes at its December meeting. The odds drop to 68% for January 2027. If the Fed stays on hold while other central banks tighten, the yield gap between US and non-US government bonds narrows. That could attract capital into markets like Europe and Australia, supporting their currencies and amplifying returns for unhedged US investors, Bory said.

A December Fed hike would close that gap. The CME odds suggest the market sees it as likely but not certain. The next test comes before that meeting, as inflation and employment data land in the coming months. Bory's positioning assumes the Fed will not validate the ECB and BOE moves at the same pace. So far, the data supports that view.

"Short to intermediate duration global government developed market bonds are not a bad spot to be, especially for those central banks that are really tethered to inflation," Bory said. "If they're going to move aggressively, that helps bond investors."