NOT TIME TO PANIC….YET
It has been a fairly safe bet that looking at how Bunds are trading will give one a pretty good idea of how many other markets are moving. We remain in the throes of a difficult to explain rising yield environment, with Bunds leading the charge to higher rates. Granted, while the current 70 bps for 10y bunds is far from being considered a high yielding security, it has been the pace of the move over the past 3-weeks that has been most disconcerting. We have subsequently seen a 10x increase in yields since mid-April, effectively wiping out all of the expected interest payments for those that bought at the lows (yields). There are plenty of theories as to why bunds have moved so aggressively, although none strike us as overly convincing in isolation. Often cited is the improving economic and inflation profile of the euro zone since the ECB started its QE program. The derivative of this discussion often includes the possibility that the ECB will halt its bond purchases early in light of these improvements. At this point, this strikes us as unlikely given that the improving inflation and economic data is relative, and reflects gains from a very low base. Given the global fears of deflation, along with the demand driven weakness that Europe faces, we would expect that the ECB would at least conclude a year’s worth of bond buying and still think that the odds favor a completion of the full program. Greece seems to always be a wild card, and its inability to strike a deal with the troika combined with dwindling cash reserves makes for a flame near an incendiary device. One theory that has been proposed is that a Grexit would actually improve EZ growth prospects, and therefore the rise in yields. Given the many steps and possible mistakes that would accompany a Grexit, we cannot grasp that we would be sellers of Bunds under that scenario. Lastly, technical positioning and liquidity concerns are often blanket statements used when there are no other good explanations exists, which is where we find ourselves and will therefore partially ascribe to this theory. We do believe and have stated before that crowded trades seem to be the norm as fundamentals have essentially given way to guessing where central bank liquidity will find it’s clearing point. Given the strong moves into both Bunds and European stocks since the start of the year, profit taking and a correction to more reasonable valuations can be viewed as healthy. More concerning would be the possibility that investor are losing faith in the ability of monetary policy to drive anything but asset values and are taking a more defensive position in light of this emerging view. We are not there yet in terms of attributing the current volatility to such a change in investor beliefs, but it bears watching as we get into the seasonally liquidity challenged summer months.