More Pressure on the Yield Curve

One of the things about targeting expectations, and factoring-in changes, is that the world moves on at a very rapid clip these days. So the ECB rate rise in now, really, yesterday’s news. The big issue today is the fact that the easing cycle in the eurozone may already be over (we need to see the data going forward before we can be sure about anything here). Anyway, one thing the markets are sure about is that eurozone interest rates aren’t going anywhere very significant in the near future, and one of the consequences of this is the fact that 10 year German bund yields are on their way down again, as is the euro. (On this I continue to maintain my long held view that the situation is asymmetric: good news from the US, and bad news from the eurozone will send the dollar up, while the opposite will simply see exchange rates marking time. All of this has a floor, of course, somewhere, but I think we are still some distance from touching it). Of course all of this implies that the dangers of yield curve inversion in the US are now real and ever-present.

European bonds may gain for a second week, their first back-to-back set of increases in more than three months, on speculation any interest-rate increases from the European Central Bank will be limited.

The ECB raised its benchmark rate to 2.25 percent yesterday, the first time it has lifted borrowing costs in five years. ECB President Jean-Claude Trichet said the increase left rates in line with the bank’s goal of containing inflation, sending bond yields to a one-month low.

“There will be no additional rate hike immediately after this one, and the cycle will end at a relatively low level,” said Kornelius Purps, a fixed-income strategist at HVB Group in Munich. “That should be supportive for the bond market.” Economists at HVB forecast one more rate increase of a quarter percentage point next year.

The dollar rose for a second day against the euro on speculation a government report will show the U.S. economy added the most jobs in four months in November.

The U.S. currency also headed for a third week of gains versus the yen on speculation faster growth in the world’s largest economy will prompt the Federal Reserve to raise interest rates faster central banks than in Japan and Europe.

“There are no signs that the economy is slowing down,” said Niels Christensen, a currency strategist at Societe Generale SA in Paris. “Rate expectations in Europe and Japan are no match for the Fed, and so the dollar will keep rising.”

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About Edward Hugh

Edward 'the bonobo is a Catalan economist of British extraction. After being born, brought-up and educated in the United Kingdom, Edward subsequently settled in Barcelona where he has now lived for over 15 years. As a consequence Edward considers himself to be "Catalan by adoption". He has also to some extent been "adopted by Catalonia", since throughout the current economic crisis he has been a constant voice on TV, radio and in the press arguing in favor of the need for some kind of internal devaluation if Spain wants to stay inside the Euro. By inclination he is a macro economist, but his obsession with trying to understand the economic impact of demographic changes has often taken him far from home, off and away from the more tranquil and placid pastures of the dismal science, into the bracken and thicket of demography, anthropology, biology, sociology and systems theory. All of which has lead him to ask himself whether Thomas Wolfe was not in fact right when he asserted that the fact of the matter is "you can never go home again".