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The world is flat – BOML

FXStreet (Barcelona) - Research Analysts at Bank of America Merrill Lynch, highlight the co-relation between term premiums and longer term rates globally.

Key Quotes

“While we have previously discussed the strong demand from foreign officials and US banks, it would be remiss to ignore the global back-drop. Government bond yields fell sharply this year, not just in the US, but across developed economies. 10y government bond yields declined by about 70bp, 90bp and 115bp in the US, UK, and Euro area, respectively. Some of this was driven by lower rates in the next few years, which can be considered a coordinated decline in central bank rate expectations.”

“But longer-term rates also declined across regions; the 5y5y rate declined by almost 150bp in the US and UK and 100bp in the Euro area. This could be a function of lower terminal rates across regions, but we believe much of the co-movement of longer term rates would be driven by term premiums. Thus, both expectations and term premiums across global bond markets seem to correlate.”

“As one would expect, during crisis periods such as the Lehman collapse (2008) and the European peripheral crisis (2010-12), the fraction is particularly high. There is either a growth shock or a flight quality move, which spills over across markets. However, the first PC has remained very high in 2013 and 2014 even though we are not at a crisis period per se.”

“This suggests recently global rates seem to be as correlated as they were during crisis periods. This could reflect deeper inter-linkages in the macro economy as well as financial markets globally post crisis. Some research also suggests uncertainty shocks such as the Lehman crisis can put downward pressure on terminal rates globally.”

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