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bund-euro dynamics and intermarket response

by Ashraf Laidi

Yields on German bunds and the euro were pressured in late London trade as ECB president Draghi reiterated in a speech at the IMF that asset purchases will go “as long as needed.” The speech sought to target the eye of the storm in the recent bond selloff, as German bonds are increasingly blamed for triggering the biggest rally in yields since the “taper tantrum” of Q2-Q3 2013 (caused be fears of Fed starting to taper asset purchases under QE3).

Globalised bund yields

The rally in euro and bond yields of the last four weeks reflects technical and macro-related factors. The yield rise resulting from unloading bunds by fund managers worried about Eurozone CPI exiting four months of negative figures was accelerated by possible signs of oil-driven reflation currents, which spilled over to other G10 bond yields. And as the euro hedges came off following the selling of bunds and Eurozone stocks (DAX,EuroStoxx), the euro gained momentum.

Intermarket response

Further macro stabilisation in the Eurozone and CPI could further push EURUSD to as high as $1.16, until more clarity is obtained by the Fed as to the timing of its rate hike. If this timing is delayed further, we could see EURUSD reaching $1.18 and bund yields pushing to as high 1.00s% from their current 0.70% in the event that bond traders perceive the Fed to remain on hold due to weak growth as opposed to weak inflation.

The intermarket dynamics prevailing ahead and the start of the ECB’s QE program had been beneficial to Eurozone stocks and bonds, at the expense of yields and gold as deflation fears were highlighted by the oil’s 50% plunge.

The retracement process of those dynamics became widespread as oil rebounded 30% from its March lows, Eurozone inflation rose from negative territory and US economic data went from bad to worse.

The all-time low in today’s release of US PPI helped weigh on US and global bond yields. But if the translate into further downside surprise in next week’s CPI release, then any gains in bond prices could be tempered by renewed losses in USD owing to the disinflation argument.

The question for next week becomes: “How recent deterioration in US data is reconciled with a largely hawkish FOMC minutes?” Any “lift-off tantrum” will need to be contained by more up-to-date Fed speeches , shedding light on that downward revisions in Q2 GDP.


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