I'm as surprised as you are... After global bond markets pulled back from the brink of oblivion in mid 2012 (led by the European systemic collapse) and worked through the aftershocks in early 2013 (remember Cyprus and Italy?), who could have guessed it would be back to save the day for US interest rates yet again?! 

This time around, we're not dealing with the European Periphery nations' solvency problems potentially causing systemic collapse for the Euro currency.  Now it's inflation.  No seriously...

If you're really really old (kidding, kidding..), or if you read a lot of economic history, you might remember inflation from the 70's and 80's.  It was sort of a big deal back then, and a lot of old people (or young people with old thoughts) still think it's an important thing.  Actually, it is always important, but it simply hasn't been the atomic bogeyman of economic destruction that it once was perceived to be.  Bond markets have long since given up on worrying about inflation being too high (last legitimate inflation scare was 2009 while we were still figuring out just how different the Great Recession was from past crises). 

The shoe has been on the other foot since then as DEFLATION takes over the bogeyman role.  My sense of the balance of literature on deflation is that professional and academic stakeholders in US financial markets still have a hard time admitting that deflation is really really bad.  I don't know if it is or isn't, mind you--simply that it's still a divisive issue.  If I had to guess, I'd say it's probably pretty bad. 

Even though that seems to be a majority viewpoint, markets continue to have a hard time allowing the threat of deflation to motivate the same sort of rallies as the possibility of asset purchases.  In other words, if the Fed fears deflation, and translates that fear into asset purchases, THEN it's OK for bond markets to rally big-time, but not simply because data indicate that inflation isn't rising.  Granted, that could have something to do with the inherent inconsistencies in measuring inflation, but even then... deflation risk in and of itself has been relatively toothless unless accompanied by the promise of policy action.

Sooooo....  where does that leave domestic bond markets in a world where the Fed's policy is currently becoming less accommodative?  We're mid-taper, rate-hike discussions for 2015 are active, and the Fed conveys a high bar for changing any of that!  Just never you mind the fact that we have insufficient inflation by the Fed's standards and that the aforementioned policy path can't help but have a desultory effect on future inflation prospects. 

In short, the US is left to cross its fingers and hope that inflation picks up even as the Fed does "disinflationary stuff.'  Oh yeah, and the source would have to be organic economic growth, and especially wage growth for Americans that still work during the day.  Who knows how that lofty aspiration would ultimately turn out, but one thing's for sure; if left to our own devices, rates were clearly on a sideways-to-higher path.

Fortunately, there's Europe.

Europe is back again, and the month of May has been an eye opener for US markets to realize just how back it is.  Granted, we're not undergoing any 2010-2012-style gyrations, but goings-on in the Eurozone have anchored yields so far in 2014 and are helping them lower at present.  Check out the following double chart showing a long-term look at US Treasuries and European debt's poster child: German 10yr debt (aka "Bunds").

Take a moment and let the shorter term (lower) section of the chart above soak in... Here's what I see:

• sideways to higher US yields after the early 2014 re-positioning
• US yields doing a good job of shrugging off falling Eurozone yields at first, but also shying away from a bigger break higher (global financial superpowers' sovereign debt markets will ALWAYS have some amount of supplementary effect on one another).  In other words, EU yields falling = second thoughts for US yields rising any more than they already were.
• Slope gets even more slippery (#2 on the chart) when a secret document surfaces regarding ECB modelling QE.  At this point US Treasuries actually break away from trend higher, but neither to they make new 2014 lows.
• When Germany (unofficial boss of the EU) finally says 'yeah, maybe we could do some QE,' and on the same day as weak inflation data, dovish talk from the other major Euro area central bank (England), and complementary technical developments in Treasuries, everyone finally jumps on the BUY button in bond markets (but just look at how much more aggressively in the EU!).

Bottom line, there's no question what's leading "La Resistance" for US bond markets in 2014.  Just like in the movies, our contact has a European accent.  The enemy they're fighting is deflation, and their leader promised impending action the last time we heard from him (Draghi press conference last month). 

Today is the day where we find out what that action is.  In fact, depending on when you wake up in the morning, it may have already happened (745am Eastern).  Markets expect the ECB to cut their deposit rate into negative territory.  This is symbolically interesting only.  More important is the "other stuff."  It's less certain what that will be, if anything, but the more it includes or leaves the door open for QE and the more aggressive the promise of future action, the more favorable the bond market response might be.  (Or play the other side of the table and say that aggressive Eurozone measures increase the chance they can create inflation, thus putting upward pressure on yields.  Longshot, but you never know).

Either way, markets have no idea what the ECB will do apart from a very likely rate cut, and conflicting ideas about how to react to it. Oh yeah, tomorrow is NFP too.  Should be a fun few days!