Bond Markets Pushing Best Levels of 2014 After ECB News
This morning's rally is all about the European Central Bank (ECB). The prospects for monetary policy accommodation in Europe have been ramping up for weeks and came to a head last Thursday when Draghi all but promised "action" at the next meeting.
Yesterday's news that the German central bank (Bundesbank) wasn't opposed to the idea made Draghi's promise even more believable. The Bundesbank, which can essentially impose its will on the rest of the European central banking system, had previously been vocal in its opposition of easing, especially as it concerned asset purchases.
Now today, a Reuters exclusive spells out how the ECB is "readying a package of rate cuts and targeted measures." Among those targeted measures are the same Long-Term Refinancing Operations (LTROs) that boosted bond markets in 2011-12 as well direct purchases of Asset-Backed-Securities (ABS), which would be comprised mainly of pools of loans to small/mid-sized businesses. The goal there is to more directly stimulate economic activity by promoting lending to smaller businesses--seen in Europe as a more effective approach than buying government debt and MBS.
With that news as the backdrop, European bond markets rallied sharply overnight, bringing Treasuries along for the ride. Following yesterday's surprise Retail-Sales-inspired rally, bond markets were even more susceptible to "snowball buying." Another way to think about that would be to consider that traders generally agreed rates would take at least a short term trip higher, but were forced to cover those bets with yesterday's reaction to the data. Bets on higher rates are "covered" by buying bonds. The more bonds bought, the lower rates go, and the lower rates go, the more traders' stop-loss levels get triggered, resulting in more buying. It's a beneficial cycle for us in the short term, but lacks a solid reassurance about the longevity of the move.
For a split second this morning, 10yr yields hit their lowest levels of the year, but are effectively still prodding the 2014 floor at 2.57 (this morning saw 2.5677, and we're currently at 2.5766). Fannie 3.5s opened at their roll-adjusted highs of the year, up 6 ticks at 102-06. They're currently up 4 at 102-04. A much hotter-than-expected Producer Price Index has almost no effect on this morning's trading. This is very much in line with the multi-year theme of not giving a damn about high level inflation data. That could start to change soon, but we're not there yet.