Bund correlation starts to weaken thanks to Greece

For weeks Treasuries have drawn investors as German bond yields tumbled. Thanks to Greece, that’s all changing.

The correlation between U.S. and German government debt is declining for a third month in April. The threat of a Greek default is driving investors to the haven of euro-area sovereign debt as Prime Minister Alexis Tsipras’s government and its international creditors face off over the terms of a bailout package and measures to reform the economy.

“The negotiations aren’t proceeding,” said Hiroki Shimazu, the senior market economist at SMBC Nikko Securities Inc. in Tokyo. “That brings a flight to quality, especially the bund market. That will lower the relationship between Treasuries and European bonds.”

The U.S. 10-year yield was little changed at 1.87 percent at 1:01 p.m. in Tokyo, according to Bloomberg Bond Trader data. The price of the 2 percent note due February 2025 was 101 5/32.

Ten-year German bunds yield 0.08 percent.

Monetary policy is also diverging in the U.S. and Europe. The European Central Bank is buying bonds in the region to head off deflation, while Federal Reserve officials debate when to raise interest rates.

The Fed will increase borrowing costs in about eight months, based on a Morgan Stanley index.

Falling Correlation

U.S. and German government debt due in 10 years and longer have a correlation of 0.94, a nine-month low based on data compiled by Bloomberg and the European Federation of Financial Analysts Societies. The figure was 0.98 as recently as February. A reading of 1 would mean they move in lock step.

Greece needs to show euro-area nations what it can deliver by mid-May to unlock new aid payments and avoid default, the European commissioner in charge of euro matters said.

Finance ministry deputies will hold a conference call April 22, followed by a meeting of ministers from the currency bloc on April 24. The gathering in Riga, Latvia’s capital, is a chance to lay out a path to a May agreement, European Commission Vice President Valdis Dombrovskis said in an interview in Washington.

Treasuries have gained this year as investors sought higher yields in the U.S. as borrowing costs fell in Europe and Japan. Long-term bond markets in the U.S. and Japan have a correlation of 0.93, the EFFAS data show.

The Bank of Japan, like the ECB, is buying government bonds, prompting concern these markets will diverge from the U.S.

Morgan Stanley

Morgan Stanley takes the opposite view.

“Down with Decoupling!” analysts at the company including Matthew Hornbach, head of global interest-rate strategy in New York, wrote in a report April 17.

Long-term yields in the main developed bond markets will rise relative to shorter maturities as central banks keep policy rates low, while growth and inflation rebound, according to the report.

“We also forecast the end of decoupling” between 10-year Treasury yields and those in Europe and Japan, the analysts wrote.

Ten-year borrowing costs will climb to 2.40 percent in the U.S., 0.85 percent in Germany and 0.75 percent in Japan by Dec. 31 in Morgan Stanley’s base-case forecast.


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