Thursday, June 11, 2015

Abrupt Normalization in Bond Market (excerpt)

One simple model of the 10-year bond yield compares it to the growth rate of US nominal GDP on a y/y basis. While real GDP fell 0.7% (saar) during Q1 on a q/q basis, it was up 2.7% y/y, confirming that the quarterly result might have been distorted by faulty seasonal adjustments. Recent economic indicators confirm that the US economy continues to grow at a moderate pace. In any event, nominal GDP rose 3.6% y/y during Q1. That’s well above even the latest yield. In the Eurozone, real GDP rose 1.5% (saar) q/q during Q1. It was up 1.0% y/y, with nominal GDP rising 2.0%.

This suggests that the rebound in yields is an abrupt normalization relative to nominal economic activity. This happened in reaction to the ebbing of deflationary fears. Expected inflation in US 10-year TIPS is up from this year’s low of 1.54% on January 13 to 1.86% on Tuesday. In addition, growth prospects seem to be improving in the US and Eurozone. While the ECB is committed to its QE program through most of next year, the Fed is likely to respond by raising the federal funds rate later this year. Expectations that the Fed will soon start normalizing monetary policy is another explanation for the abrupt normalization of bond yields.

Today's Morning Briefing: Bond Bath. (1) Blondes vs. bonds. (2) Bonds vs. bunds. (3) Where do we go from here? (4) From abnormal to less abnormal. (5) Deflation fears ebbing. (6) A simple bond model. (7) Draghi deserves credit and blame. (8) Dudley says Fed policy is market dependent. (9) Tranquility in the commodity pits. (10) Riding the Age Wave. (More for subscribers.)

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