MBS RECAP: The Real Drama is in Europe, but Little to do with Greece

If you missed it, or are otherwise looking for a recap on why bond markets got crushed today, here it is.  Nothing materially changed from that update, and that's no surprise considering the source of the drama was Europe.

For those of you who don't click links, suffice it to say that the European Central Bank is not the Federal Reserve.  I'm still dumbfounded by the behavior we've witnessed today and the lack of outrage in the marketplace.  I mean, I can clearly see the outrage expressed in trading levels, but I'm not seeing nearly the amount of media coverage such a thing deserves.

So what was the big deal? 

It's actually not too complicated.  Europe fought tooth and nail for several years to roll out a QE program.  They finally launched it in early 2015 and specified the amount and timing.  When markets began speculating that the amount might be less or the timing might be cut short, the head of the European Central Bank provided reassurance that the timing and amounts were predetermined.  And now today, he said they weren't.  It's really that simple.

For the sake of perspective, he did say that the European economy requires the full program for the full amount of time (Sep 2016).  The problem is that he also said that the program could end early if there was a sustained adjustment toward inflation targets.  Jeez... To reiterate some of my incredulity from this morning, this is dirty pool.  The Fed has been widely criticized, to be sure, but I couldn't imagine the backlash if they pulled a similar move with one of our QE iterations that had a predetermined amount of bond-buying. 

It's a surefire way to cause chaos.  And that's exactly what it did.  German Bunds sold off 20bps today (vs 10bps in US Treasuries).  As an aside, I did see some media attention paid to the Greece situation.  It seemed to insinuate that a deal with Greece was responsible for the European bond market sell-off.  Let's be very clear here.  When a Greek debt deal becomes imminent, Greek bond markets (what's left of them) respond.  Greek yields fall while German yields rise.  With that in mind, let's take a look at today's market activity in Greek and German 10's if we set them against their relative trading ranges from a few months ago (i.e. lining up March/April highs and lows):

In the chart above, please note that the yellow line (Greek yields) is on an inverted scale in order to show the correlation.  In other words, the higher Greek yields are at the bottom because higher Greek yields correspond with lower German yields.  The moral of the story is that, while there was some correlated movement in April, Greece has flat-lined since then and German yields are more concerned with the many hundreds of billions of Euros they might lose due to improving economic metrics and more disconcertingly, central banker discretion.