Bond Sell-Off Continues, Squeezes Euro Higher, Weighs On Stocks

The dramatic sell-off in European bonds continues apace today. In part, sparked by the easing of deflation pressure, there is a taper tantrum of sorts being played out. The 10-Year German bund yield is 18 bp to 76 bp. You may recall that about a month ago it was at 5 bp, and everyone knew it was going to go negative.

This is the first time since January 2014 that the yield has moved above its 200-day moving average. The 78-80 bp area represents an interesting technical area, corresponding to the high from December 2014 and also a minimum retracement objective of the slide in yields since January 2014. Above there and the 90-92 bp area attracts.

The sell-off in bunds is serving to drag down the entire European bond complex. At the beginning of the rout, the spreads with the periphery widened. It is not unusual for the peripheral premiums to widen in a higher interest rate environment. However, more recently, including today, the premiums are narrowing.

The market appears to have all but ignored the smaller than expected rise in German factory orders (0.9% vs 1.5% consensus). French industrial output figures were also softer than expected (-0.3% vs 0.1% consensus), though French manufacturing was stronger. Specifically, manufacturing output in France rose 0.3% (consensus 0.2%) and the February series was revised to 0.5% from flat. The market has already largely taken on board the fact that the euro zone economy accelerated in Q1 and surpassed the US, which after this week's trade blowout, will likely be revised to show that the world's largest economy actually contracted in first part of this year.

The dramatic position adjustment underway in Europe appears to be the key factor lifting US yields. It is not the US data. The pace may be of some concern, but the direction probably is not. Specifically, there is a gap between the Fed and the market views. Yesterday Yellen again warned that US long-term rates could rise after the Fed lifts the Fed funds target. To avoid this being disruptive, it is best if the adjustment were stretched over a period of time.

While a recovery in the US economy from the likely contraction in Q1 already seems underway, the data has yet to show a strong rebound. Tomorrow's national employment data is the first hard data for Q2 outside of the weekly initial jobless claims, which have continued to trend lower. Yet the productivity data (Q4 14 and Q1 15 showed the largest back-to-back decline since 1993) warns that the growth potential of the US is likely lower than many appreciate.

Growth is ultimately a function of how many hours are being worked and output per hour. Given the demographics and labor force participation rate, hours worked can rise about 1% a year. Productivity is currently growing around 0.6% year-over-year. While productivity can rise, it is unusual to get a strong rise this late in the business cycle. This back-of-the-envelop calculation would put trend growth in the US near 1.6%-1.7%. Growth faster than something around that figure would be consistent with absorbing excess capacity and labor market slack.

The UK election is underway. The first exit polls for the UK election are expected around 6:00 pm EST (22:00 GMT). Many seats are truly competitive, and of course, the focus will be on these seats. A clear picture of the voting emerge around midnight EST (4:00-5:00 GMT). Most projections still give a minority Labour government the highest odds.

There are two other developments for global investors. First, Norway's central bank left rates on hold. There were some expectations among economists for a cut, and when it did not materialize the the krone strengthened. However, the central bank made it clear that a cut in June could still be considered and this appears to be help the krone stabilize after gaining about 1.25% against the euro.

Second, Australia's jobs data was somewhat disappointing. There was a 21.9k drop in full-time jobs in April, though the March series was revised higher to show 41.3k full-time positions were created rather than 31.5k. The unemployment rate ticks up to 6.2% from 6.1%, though the participation rate was unchanged at 64.8%.

The US dollar itself is mixed today. It is slightly firmer against the dollar-bloc and sterling, but weaker against the continental currencies and yen. The unwinding of the long European asset/sort euro position, coupled with the disappointing US data appears to be the main driver. A move above $1.14 could quickly see the euro extend toward $1.15, which is the next important technical area. As we have noted, using the speculative positioning in the futures market as a guide, the position adjustment has lagged in the euro, but now seems to be playing catch-up.