Yields in the main bond markets fell to their lowest levels for a generation, prompted by the perception that the world economy had entered an era of disinflation with the promise of near-price stability ahead. In turn, the slump in bond yields prompted a surge in global share prices, narrowing the yield gap between the two markets.
The first Fed tightening in almost five years put paid to that. Fears of a new Black Monday quickly followed. Although clearly overblown, it is a warning that the best may be over for both bonds and stocks.
In the days since UK rates have edged lower, the Bundesbank surprised the markets with a half-point cut in the discount rate, leading other European rates down, and US inflation figures pointed to stable prices. But the markets were not impressed. Long bond yields have risen in London, New York and Frankfurt.
The key to market pyschology lies with the US. It is difficult for Europeans to understand what Americans are going through. Here we look forward to further falls in rates. Across the water, they are well aware that the interest rate cycle has turned up, perhaps sharply.
This week's events, moreover, demonstrate that European markets are no longer so sure that they can remain comfortably decoupled from the US. The Bundesbank cut failed to elicit the expected favourable reaction.
In the US, meanwhile, the markets ignored the inflation news and focused instead on rising industrial prices. Investors dumped US Treasuries and by yesterday were selling European bonds as well. The unspoken fear is that we may never see the expected lower European rates, as worries grow about weakening currencies.
Next week, the markets will hang on every word uttered by Alan Greenspan, the Fed Chairman, who testifies to Congress on Tuesday. Throw in a dollop of uncertainty created by US-Japan trade friction and there seems little reason to buy.Reuse content