This summer, investors bet that developed-world central banks would move in tandem when exiting crisis-era stimulus.
On Thursday, the European Central Bank gave notice that its stimulus will loiter longer, widening a gap between monetary policy expectations in the eurozone and U.S. that is set to further influence their financial markets.
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The ECB said it would halve its monthly bond-buying to EUR30 billion but keep buying until the end of September 2018, while reiterating that interest rates would remain at current levels well past the end of the asset-purchase program.
That sent the euro down 1.4% against the dollar, its biggest daily decline since the U.K.'s Brexit vote last year, while boosting eurozone bonds and equities. The ECB's move cemented investors' growing sense that it would continue the extraordinary monetary stimulus that has supported local markets. The realization that the central bank is in no hurry to unwind stimulus has already acted as a weight on the common currency and sent the gulf between U.S. and German government bonds to multiyear highs this month, trends that investors now expect to continue.
The euro continued its decline on Friday, falling 0.2% to $1.16.
Meanwhile, investors' expectations for U.S. interest-rate rises have climbed over the last month, the Bank of Canada has been raising rates, and most expect the Bank of England to raise borrowing costs for the first time in a decade in November. The Federal Reserve is expected to raise its benchmark rate for the third time this year in December, and this month it started reducing its bondholdings.
"There's this continued divergence between what the ECB is doing and what the [Fed is doing]," said Antoine Lesne, who runs SPDR strategy at State Street Global Advisors. "This tone of caution [from ECB President Mario Draghi] lets the market believe they're going to be in there for quite some time."
The ECB's decision to extend its asset-purchase program until September was taken by many investors as a sign that an interest-rate rise remained a distant concern, given the central bank's continued guidance that this won't occur until well after the end of its purchases. Following Thursday's meeting, investors' expectations for a rate rise in the eurozone were pushed back to June 2019 from March 2019, according to derivatives markets.
"The longer the program goes on, the further into the future any prospect of a rate hike is," said James Athey, investment manager at Aberdeen Standard Investments.
The central banks of Europe, the U.S. and Japan knocked rates to ultralows and began to buy bonds in a bid to stimulate economies that had been bit hard by the financial crisis. But as economic growth has gathered steam, most central banks have begun to either tighten those monetary taps or hint that they will do so.
The divergent policy expectations between the U.S. and eurozone have pushed the yield gap between two-year Treasurys and two-year bunds to its widest since 1999, when the euro traded around $1.05. Germany's two-year bunds now offer yields 2.35 percentage points below two-year U.S. government bonds, according to Tradeweb.
Bastien Drut, fixed-income and currency strategist at Amundi, said he expects that gap to widen further in the coming months as the Fed continues reducing its balance sheet and raising short-term interest rates.
That also has helped stall the rapid move higher for the euro that pushed the currency up 13% against the dollar in the first eight months of the year. On Thursday, the euro fell to $1.1655, wiping out all its gains from the start of the quarter. The difference between government bond yields is often used as an indicator in currency markets, as investors tend to shift to areas where investments offer higher returns, weakening the currency in the region where yields are low.
The euro's ascent in the first few months of the year is over for now, said Philippe Waechter, chief economist at Natixis Asset Management. "The ECB doesn't want to take any risks on the current economic recovery" by changing policy too quickly, he said.
While Thursday's news was largely expected, many investors welcomed the ECB's announcement as confirmation the bank would take its time unwinding the policies that have propped up the region's financial markets for several years.
The Euro Stoxx 50 index of eurozone companies rose 1.3% on Thursday, while Germany's DAX index ended at a record high and France's CAC-40 climbed to its best finish since the start of 2008. Eurozone stocks have added roughly 11% since the ECB first announced its asset-purchase program in January 2015. Stocks were up again on Friday.
Corporate bonds also rallied after Mr. Draghi said the ECB will continue to buy "sizable quantities" of the securities. The annual cost of insuring against a default on $10 million of European investment-grade debt using credit-default swaps declined $2,000 to $53,000, according to the Markit iTraxx Europe credit-default swap index.
Yields on 10-year German government fell to 0.404% Friday, from 0.464% ahead of the announcement. Assets from the weaker European economies that investors say have benefited most from the bond buying were doing well, with Italian 10-year government bond yields down to 1.932% on Friday, from 2.017% earlier. Yields move inversely to prices.
Jon Sindreu and Christopher Whittall contributed to this article.
Write to Riva Gold at email@example.com and Mike Bird at Mike.Bird@wsj.com
(END) Dow Jones Newswires
October 27, 2017 06:32 ET (10:32 GMT)