Thursday was one of the worst days for bonds in recent memory as a combination of decent data, corporate supply, trade optimism and a bearish impulse from Europe catalyzed a rout stateside.
It was among the worst days for TLT since Trump’s election, and it came just days after the vehicle wrapped up its second-best month since the crisis.
Five- and 10-year yields jumped the most since January 4, when Jerome Powell kicked off the Fed’s dovish pivot which culminated nearly 7 months later in the first rate cut since the crisis.
Across the pond, 30-year yields in Germany moved back into positive territory for the first time since early August following lackluster demand at auction for French and Spanish debt.
While European spillovers added to the bearish impulse in US bonds on Thursday, Goldman notes that “Bunds and Gilts have been the largest source of the cumulative bullish impulse to the global rate rally this year, with the decline in Treasury yields exerting downward pressure on yields [only] more recently”.
Going forward, Goldman says the US will likely need to take the baton if the bond rally is going to continue – and by “take the baton”, we mean the US economy needs to roll over and the Fed needs to get more dovish, because it’s hard to see how the economy could get much worse in Europe, or the ECB more accommodative.
According to the bank’s estimates, expectations for policy easing from the ECB have driven around 30bp of the rally in 10-year German yields and have spilled over into Treasurys and Gilts to the tune of -14 and -15 bps, respectively.
The only way European rates can continue to lead in terms of driving the bond rally is if growth and inflation outcomes continue to worsen across the pond, or if the ECB manages to deliver a dovish surprise. While it’s certainly possible that the economic backdrop could get gloomier still (see Thursday’s data out of Germany, for instance), recent rhetoric from ECB officials suggests many are lining up against Mario Draghi when it comes to the prospect of restarting net asset purchases.
“Given markets are already pricing in a depo rate cut over 15bp and a substantial amount of QE, it is hard to see that happening”, Goldman says, referencing the high bar the ECB faces in satisfying market expectations for easing this month. Indeed, a disappointment on that front could entail a 7-10bp bearish spillover effect to 10-year US yields, the bank writes.
But even as Goldman says “the mix of data and policy space in the Euro area suggests there isn’t enough room to generate the sort of sustained [bullish bond] impulse witnessed so far this year”, the bank thinks there’s scope for the evolution of the data and policy in the US to put further downward pressure on global yields.
“In the US, our macro factor decomposition suggests that the big contributor to the yield rally has been growth concerns and less so monetary policy or inflation concerns, in part reflecting heightened trade war tensions this year”, the bank notes, adding that “a bullish impulse could therefore arise from either a deterioration in the hard data or a re-escalation in the trade war which would likely result in a shift to an easier policy stance as the Fed changes its communication to reflect this”.
Thursday marked the opposite of that – the data was solid and trade tensions abated.
So, if you’re looking for a continuation of the bond rally, you may have to hope for a further deterioration in the US economy and a total Fed relent. Europe has done all it can when it comes to driving global yields lower. Or if the bloc can do more, it would probably entail a recession.