Broad market volatility was once again elevated in May. Long-end Treasury yields leaked higher in the middle of the month amid a stronger dollar and higher oil prices, with the 10-year yield reaching a 7-year high of 3.11%. However, in the last week of May, political concerns in Italy and, to a lesser extent, Spain sparked a global flight-to-quality trade that pushed the 10-year yield down 18 basis points (bps) to 2.75% (36 bps swing in just seven trading days). Italian 2-year bond yields surged 150 bps higher in just one day, bringing back fresh memories of the Eurozone debt crisis of 2011/2012. There remains a large amount of excess liquidity in European markets from the European Central Bank (ECB) though, and if we learned anything from recent crises, it’s the power of central bank liquidity in responding to short-term pockets of market volatility.
Nevertheless, if larger-scale credit concerns in Europe are overblown, there are growing questions regarding the viability of the current economic recovery in the region. Economic data have softened in Europe in recent weeks, particularly relative to expectations, and the European Economic Surprise Index has gone from a 7-year high beginning 2018 to a 6.5-year low in early May. With softer data, the EUR/USD exchange rate has fallen from 1.25 in early February to 1.15 more recently, and expectations for the ECB to begin reducing policy accommodation in the next 6-12 months have also diminished. The June 2019 Euribor contract has fallen 25 bps since early February as well and is closer to the current spot rate. In other words, the market has effectively unwound pricing for a June 2019 ECB rate hike.