In Morgan Stanley’s latest FX Pulse, analyst Hans Redeker spotlights this chart
Photo: Morgan Stanley
Basically it shows a shift. Up until recently, an increase in Spanish and Italian yields was associated with a decrease in German yields.
But now Spanish and Italian yields are basically at new highs, while German yields are only at their old lows.
The lesson: Whereas before, people were dumping Spanish and Italian det and buying German assets, now we’re seeing a complete avoidance of EUR-denominated assets altogether.
When peripheral bond yields rise and German bond yields fall, it indicates investors are rebalancing portfolios without leaving the EUR denominated bond environment. Indeed, the German bond market’s ability to absorb the liquidity coming out of peripheral markets has helped stabilise the EUR. However, rising spreads combined with German bond yields no longer falling suggests portfolio rebalancing is no longer predominantly within EMU. Instead, it suggests an increasing amount of funds obtained from the sale of peripheral bonds may now leave the currency area, which is EUR-bearish. Renewed inflows into the US Treasury market, as shown in the recent TIC report, support this thesis.
While this is arguably Euro bearish, it is only one piece of the puzzle. As we noted earlier, there’s another phenomenon going on, of banks dumping their foreign assets to raise cash, a trend is which Euro bullish.
Either it will be interesting to watch and see if US Treasuries significantly outperform German bunds, emerging as the safe-haven of choice.