At many times over the course of 2014, we have highlighted the significant influence that global economic factors are having on domestic bond yields. U.S. interest rates have fallen this year despite better U.S. economic data and declining accommodation from the Fed as they wound down QE, two factors that would traditionally cause yields to rise. Why? Economic weakness and low interest rates around the world are making U.S. Treasury bonds look relatively attractive, despite what are historically low absolute yield levels. Bank of America Merrill Lynch published a research paper last week that supports this explanation. According to the authors, Priya Misra and Dora Xia, the correlation between global factors and U.S rates has been at crisis era levels during 2013 and 2014. In other words, the current correlation is equivalent to what it had been when Lehman collapsed in 2008, despite there having been no major financial crisis over the last two years. As the large brokerage firms begin to publish their 2015 market outlooks over the next few weeks, it is a safe bet that the question of whether this correlation can continue will be addressed. The Fed seems to have little concern over global factors when setting monetary policy, but that doesn’t always mean the market will agree. Stay tuned.
Sources: BAML, Federal Reserve