Recap 6-18-13: Why is the correlation between US and EU yields so high?


Tomorrow’s FOMC meeting has now been dissected a million times over. In treasury space, positioning appears to be pretty clean, based on recent price action and CFTC data. In EM, however, deleveraging pressures appear to continue to persist. I don’t have much of an opinion for tomorrow. But I do think that much of the money that was taken out of fixed income assets over the past month will need to find a home. At the moment, that appears to be equities. In a testament to the bid for stocks, the S&P is now solidly in the green for the month.

One of the other interesting aspects of recent price moves is how correlated EU yields have been to US yields. Given that this tapering talk has been out of the Fed, while the ECB just eased a couple months ago, you’d think that the correlation would’ve declined. And given that the US economy look much closer to ‘escape velocity’ than the EU economy, which is forecast to remain in a recession until the 3rd or 4th quarter, you’d think that would cause correlation to decline even further. Instead, correlation has remained at roughly average levels. (~60% on a 3m basis)

This was also the pattern in global rates in the last cycle. In effect, the ECB appears to be broadly content allowing the transmission of its monetary policy to be driven by the Fed.

Note however, that the differences in mandates goes a long way towards explaining this phenomenon, at least historically. Since inflation tends to get propagated via trade, and since the ECB has an inflation mandate only, arguably policy rates across the Atlantic should be reasonably highly correlated – or at least roughly as correlated as inflation has been. And interestingly enough, swap yield correlation and inflation correlation between the two regions are very roughly similar. (57% on a 24m trailing basis)

However, this is all predicated upon the idea that inflation correlation will continue. And that assumption appears to be getting weaker. The size of the recent economic contractions and the very different ways each region have acted in response has already driven a decline in business cycle correlation. (24 month PMI correlation below) And with the reduction in oil price volatility due to the US shale oil boom, the most volatile and common component of inflation in both regions are likely to become muted. This suggests that inflation correlation is likely to decline over time, to something more like the levels seen in the 90’s.

In aggregate, this suggests that the yield correlation across the Atlantic could fall over time.

Separately – this is kind of crazy: ““The whole society must take action! Let’s engage a massive people’s war against blackmail crimes using Photoshopped obscene pictures,” they blared.”


  • US Core CPI was stable at 1.7% as exp
  • US Housing Starts improved to 914k in May vs 950k exp and 853k prev
  • German ZEW rose to 38.5 vs 38.1 exp and 36.4 prev
  • UK CPI rose to 2.7% in May vs 2.6% exp and 2.4% prev
  • Obama said in an interview that Bernanke has stayed longer than he wanted
  • RBA minutes:
  1. Mining investment appeared to be close to its peak and was expected to remain at a high level for the next year or so, although the exact profile was difficult to predict.
  2. the latest ABS survey of firms’ investment intentions for 2013/14 indicated that modest growth in non-mining business investment was likely over the course of the year ahead.
  3. There were also signs that the appetite for borrowing in the household sector was picking up, and the housing market generally appeared to be improving,
  4. Forward-looking indicators of labor demand were consistent with further moderate growth in employment.
  5. The exchange rate had also depreciated noticeably, though it remained at a high level considering the decline in export prices that had taken place over the past year and a half. It was possible that the exchange rate would depreciate further over time as the terms of trade declined, which would help to foster a rebalancing of growth in the economy.
  6. The Board also judged that the inflation outlook as currently assessed might provide some scope for further easing, should that be required to support demand.

The Journal said China’s banks are urging Beijing to ramp up liquidity injections into the economy in a bid to bring down borrowing costs and ease a worsening cash shortage. .

Upcoming Data:

  • Wed: BoE Minutes, FOMC, BoC Governor Poloz Speech
  • Thu: EU PMI, UK Retail Sales, US Jobless Claims, Markit PMI, Philly Fed, Existing Home Sales,
  • Fri: Canada CPI, Retail Sales,