Stocks are starting to respond to the unusual volatility in the global bond and currency markets that are helping reverse existing trends in bond yields. This is weighing on market sentiment today, with the major indexes today modestly in the red.
The uptrend in bond yields is particularly notable in Europe, with benchmark 10-year German government bond yields now at their highest level of the year. This is a big shift in the European interest rate complex, with the German Bunds reversing from their earlier course of moving towards the 0% rate just a couple weeks back to now close to 1%. The trend isn’t restricted to Germany alone – we see it in the Italian, Spanish and other government markets as well.
This bond-market development has arrived at the same time as the Greek drama has reached its drop scene. But thankfully Greece isn’t driving this bond market sell-off. The primary driver of this trend is the region’s improving economic fundamentals, which is prompting market participants to question the longevity and staying power of the European Central Bank’s ongoing QE program.
The region was under threat from deflationary forces for a whole, but recent data shows that the inflation may finally have bottomed. The ECB President was very dovish in his comments about the course of monetary policy going forward, but the rest of his Wednesday press conference added further to bond and currency market volatility.
[Hear: San Andreas – Financial Fault Lines in the Bond Market]
This isn’t a Europe-only issue — it is far more relevant this side of the pond, particularly with the Fed getting ready to start its monetary policy tightening process. The U.S. economy’s soft showing in Q1 and the mixed start to Q2 removed June and even raised questions about September as the likely interest rate lift-off starting point for the Fed.
The tone of recent data has been overwhelmingly positive, with the factory sector ISM survey this week showing a nice improvement. Housing surveys and monthly automobile sales are showing even stronger momentum. We will get the May non-farm payroll report tomorrow morning, but all labor market readings suggest a spring rebound in the jobs market. All in all, the U.S. economy is shaking off the Q1 blues and heading towards at least a +2% GDP growth pace in the current quarter.
The reduced differential between the U.S. and German bond yields is starting to show up as increased volatility in the currency market as well, with the common currency gaining ground relative to the U.S. dollar. If sustained, this currency market trend reversal is a net positive for U.S. companies as it will help boost their earnings power on the margin. That said, the ongoing market developments bring back memories the ‘Taper Tantrum’ in the not-too-distant past.
Related podcast interview:
Don Coxe: Bond Bull Coming to an End – Bonds Now a Center of Risk
