What is Driving International Bond Markets? Look to Germany.

Global Investment Opportunities

global-globe-ssMore and more people are saying that investors in bonds should look toward Germany…more specifically, Frankfurt…to see what is driving international bond markets.

In the current situation, the size of the market doesn’t matter…the German bond markets totals around $1.5 trillion whereas the US Treasury market totals more than $12.0 trillion.

On August 28, 2014, the Federal Reserve held more than $2.4 trillion in US Treasury securities.

Yet it seems as if the market for German Bunds is driving world markets.

In late April and early May, the yield on the 10-year German bund was around 1.50 percent.

Since then the yield have plummeted with the yield dropping below 1.00 percent on August 22 of this year.  The current low was reached on August 28 at 0.866 percent and now the security is trading just above 0.90 percent.

The thing is other yields in Europe have followed the decline in the German bund.  Historic lows have been reached for French debt, 1.217 percent, and for Spanish debt, 2.25 percent.

Note that these yields are all below the yield that can be earned on 10-year US Treasury notes, which closed yesterday at 2.41 percent.

The focus is also on Frankfurt this week because the European Central Bank meets there on Thursday.  Mario Draghi, the president of the ECB, has been in the global news daily over the past several weeks.  The reason is that the economies in the eurozone are not doing so well.

Over the past several weeks it has been learned that Italy has slipped into its third recession over the past five years.  The growth rate of France is basically flat, and the German economy is hardly growing at all.

Furthermore, disinflation continues.  Prices in August only rose at an annual rate of 0.3 percent, down from 0.4 percent the month before.  The decline in the inflation rate this year has been continuous.  There is fear that the eurozone may be slipping into a period of secular stagnation, not unlike that which has been experienced in Japan.

But, as these developments have gained more and more attention, focus has also turned to Mr. Draghi to see how he will respond to the situation.  It is this attention that is causing the investors of the world to keep their eyes on Frankfurt.

It seems as if what happens in Germany is going to dominate the behavior of the world’s bond markets over the rest of the year.

Last December, almost everyone…myself included…believed that longer-term interest rates were going to rise in 2014 and that the yield on the 10-year US Treasury note would close the year over 3.00 percent…perhaps even as high as the range of 3.25 percent to 3.50 percent.

The belief was that the US economy would grow a little faster this year, maybe even reaching a 3.0 percent, year-over-year, growth rate by the end of the year.  Unemployment, it was felt would drop even further.  Attention would be given to the US economy and US bond yields.

Furthermore, the Federal Reserve was seen as ending its third round of quantitative easing and this, it was felt, might even cause some upward pressure to be felt in money market interest rates.

Obviously, these things have not happened, even though the Federal Reserve will end its quantitative easing in October.

In Europe, the bond yields have fallen because the estimates of real economic growth in the eurozone have declined and because investors feel that disinflation might even turn into deflation.

Both have played a role in the decline in European interest rates.   I mean, can you imaging that the yields on French and Spanish sovereign debt are below the yields investors can obtain on US Treasury securities?

And, the drop in European yields have driven the yield on the German bunds below 1.00 percent because the German bunds still represent a “safe haven” for investor money.

All of this has just put more attention and more pressure on Mr. Draghi.  Remember, it was Mr. Draghi that almost two years ago said that he would do whatever is needed to keep the eurozone together with its common currency.

Well, now investors are looking for Mr. Draghi to deliver.  He has been reluctant to move to a policy of quantitative easing similar to that run by the Federal Reserve.  He has not been convinced by the US effort that quantitative easing has really contributed much to stimulating more economic growth.

And, it has put the Fed in an awkward position at the close of the period of quantitative concerning the issue about how the Fed is going to reduce all the liquidity it has pumped into the banking system.

So, all attention is now on Europe…on Germany…on Frankfurt.

What is going to happen?  Most people believe that Mr. Draghi will opt for some kind of quantitative easing, whether it be through the purchase of sovereign European debt or through the purchase of asset-backed securities.  Just for psychological reasons, he is going to have to do something more than he has in the past…something a little more dramatic.

If you are interested in bonds then keep you eyes on what Mr. Draghi and the Europeans are doing.  What they do may dominate world bond markets for the rest of this year.

About John Mason
 John MasonJohn has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.

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