The GDP report and statement from the Federal Open Market Committee (FOMC) were supposed to be Wednesday's big events, but they were minor distractions, especially for the bond market. The GDP was predictably weak and the FOMC was predictably non-committal. If you care, the Fed is not at all likely to tighten in June, but it left the door open just a touch. I maintain the bond market will dictate to the Fed when it will tighten. The Fed will be a follower.
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The big event yesterday was the blow-up in the European bond market that spilled over into the United States. All European bond rates rose. The German 10-year eventually closed at 0.29%, which was up from 0.16% the prior close and 0.05% just a few days ago. The economic data has been consistently improving, and even the tide in Greece could be turning toward cooperation. When the European Central Bank started buying bonds it seemed obvious the lack of German bond supply would force yields into the negative because current bond holders would not be willing to sell bonds. However, it appears some of the presumed bond holders did decide to become bond sellers.
In addition to the European bond market, some of the angst in U.S. bonds yesterday was also related to the weak dollar. The dollar was getting crushed, and bond traders feared currency losses would force some foreign bond buyers to sell. Remember they sold euros to buy dollars and then bonds. They need the dollar to stay strong, and that’s what they are betting on. Home currency losses could easily swamp the minimal rate differential. Personally, I think this threat is real. However, I also think it’s too early to suggest this is a “thing.”
The U.S. bond market followed the German market down in rates through most of 2014. Apparently, it cuts both ways, and bond traders simply weren’t and aren’t prepared for that. As of Thursday morning, the German 10-year yield is up again to 0.35%, but the U.S. bond market is not following yet. Perhaps month-end buyer bond index fund managers are staving off the traders' urge to blindly follow German yields. Bond prices are slightly higher to start the day, but unless there is some news or a reversal in the German bond market, don’t be surprised if you see bond prices sag later today.
Dwight Johnston is the chief economist of the California and Nevada Credit Union Leagues and president of Dwight Johnston Economics. He is the author of a popular commentary site and is a frequent speaker at credit union board planning sessions and industry conferences.