MBS Live Day Ahead: New Narrative? Another Case of Europe's Influence Over US Rates

By: Matthew Graham •

From 2011 through the middle of 2016, the European economy, monetary system, and policy landscape had an extreme amount of influence over volatility and outright levels in the U.S. rates market.  

  • 2011-2012 = peak EU financial crisis, Greek debt drama, peripheral credit spread concerns (remember the PIIGS?), Grexit debate
  • 2014 = The year that ECB outright asset purchases came into focus
  • 2015 = Final approval on bond buying early in the year and a big blowout rally in EU bonds by April
  • 2016 = Brexit helped US 10yr yields just barely break new all-time lows.

All of these bullet points are highlighted on the following chart, including some non-EU-specific events such as the taper tantrum and 2018/2019's "global growth concerns."  The charted lines are simply the US 10yr yield and Germany's 10yr yield (which is viewed as the benchmark for the EU due to Germany being by far the largest economy and the most political clout.

All this to lay out the case that when EU markets make enough noise, U.S. markets can't help but hear it.  One could argue that the EU has been largely silent since Brexit.  Sure, the EU was part of the "global growth concern" rally in 2019, but that was mostly about the US/China trade war and a correction to overly tight Fed policy.  Now in the age of covid, a resurgence of cases in the EU (new records in many countries) brings the correlation with US markets back in focus.  The following chart gives us an idea of how much bigger the recent volatility has been in Europe.

Zooming in a bit, we see that European bonds helped offset the upward pull from domestic stocks. Then, as soon as stocks leveled off, Treasuries had the green light to rally.  This chart also shows how much the EU bond rally accelerated just this morning, which is why we're talking about it!  (Incidentally, as I type this, a bounce in EU bonds is leading a bounce in Treasuries).

The bottom line is that we need to add "big moves in EU bonds" to our list of potential inputs in the near term, along with the known unknowns like election results, stimulus timing, and the longer-term covid-related impacts on the economy.