The yield on ten-year German bunds dropped below 1.30 percent again yesterday and was trading to yield 1.26 percent today. Both the yield on the ten-year U.S. Treasury bond and the ten-year TIPS U.S. Treasury have dropped, the ten-year bond fell below 1.90 percent to 1.85 percent yesterday while the ten-year TIPS declined to a negative 64 basis points. These two yields have tended to move in tandem in recent years.
It has been the case during the last couple of years that when international financial markets are moving away from risk they move into the sovereign German debt and into U.S. Treasury securities. The usual culprit causing this flow into Germany and the United States is the freckles eurozone.
It seems as if that is what is happening now. The eurozone has not handled the Cyprus situation well, at least according to the participants in the financial markets.
Today the Cyprian banks are opening and people can now get their money out of the banks. There are capital controls on the movement of funds out of Cyprus, but still the money can run. These capital controls are a first for the eurozone and evidence of how serious the officials believe the situation to be.
Once again, the European officials have failed at their task. They have once again tried to kick the can down the road and muddle through the most recent crisis.
Consequently, the euro dropped below $1.28 yesterday and also fell against the U.K. pound and the Japanese yen. The European problems are not getting solved.
Many claim that the problem is one of a lack of leadership. Daniel Henninger (subscription required), in his most recent column in the Wall Street Journal, writes about "the never-ending European financial crisis" and states that "Germany's Angela Merkel presides over a great nation whose people have little stomach to lead anything ever again."
Germany should be leading the charge in Europe for it is one of the few nations in Europe that has its fiscal affairs in shape and is a creditor nation. Most of the others, Italy, Portugal, Spain, Greece -- and Cyprus -- are debtor nations experiencing fiscal chaos and economic depression.
But, every time Germany steps out to take any kind of leadership position, its officials are branded as "Huns" and "fascists" and "Nazis". (See column in the Financial Times by Gideon Rachman -- registration required.) I think I would be a little careful in trying to exert any kind of leadership in this kind of hostile environment. And, so the European problems continue.
I believe Angela Merkel is trying to lead the eurozone out of its crisis, but under existing attitudes is finding it a very hard task to accomplish. (For more on this see "Where is Germany Going? Is this the German Plan?")
Furthermore, the structural problems that need to be solved within the eurozone -- like, fiscal union and a banking union -- are so complex and so tied up in national interests that the probability of assembling all of the eurozone countries to come together and reach some form of coherent re-structuring is quite low. And, I believe that this statement is overly optimistic.
Thus, financial markets will continue to swing one way this week and another way next week as the political battles play out. The eurozone financial crisis is not going to be resolved until the crisis gets bad enough that desperate nations will swallow some of their pride and actually negotiate.
The major indicator that this period of risk on-risk off trading is over will be when the yield on TIPS securities becomes positive again. The fact that these yields are negative are an indication of how much fear there is in the world. The yield on TIPS bonds turned negative when global investors became so concerned about the financial situation that they went into these securities even though they are currently receiving a negative yield. The yield has fluctuated up and down as world financial sentiment has varied, but they have remained negative now since October 2011, the time the European financial crisis accelerated.
I believe that the yield on longer-term TIPS issues will become positive once again only when global investors believe that Europe has gotten its act together and has re-structured itself sufficiently to finally move on into the future. I don't see this happening in the near future.
This, of course, skews the whole bond yield curve in the United States. The Federal Reserve has gotten a lot of credit, if you want to call it that, for keeping U.S. interest rates so low. My reading of the situation is that the Fed is just riding on the coat-tails of the "flight from risk" movement of funds in the world. There is little or no pressure on U.S. interest rates to rise to any degree as long as this money continues to flow into the United States … and Germany.
I am on the record for arguing that U.S. interest rates should rise in 2013, but, this rise, I believe, will just keep on getting postponed as long as the European crisis continues to drag on.