Volatility dominates

• Dovish Fed prompts markets to rally 
• 10y Treasury yield back below 2% 
• The rise in the US dollar fades

News impacts markets more so than before. The Federal Reserve Open Market Committee created a big surprise with the downward revision of its forecasts, including for Fed funds rates. Wall Street rallied and the 10 year treasury yield at some point fell a whopping 14 bp. The dollar weakened. The following morning, Bund yields obviously also declined and Italian and Spanish yields even more. Earlier this week however, peripheral spread had widened significantly against Bunds, reportedly in relation with a surprisingly big 30 year bond auction in Italy. Four factors underpin this regime of higher volatility. One, on the eve of the start of US monetary policy normalization, the prospect of a less generous liquidity environment increases sensitivity to news. Two, years of very low rates have created an addiction, so there is relief if the ‘party’ can continue for a while. Three, in the Eurozone we are still in the process of discovering the implications of QE on bond yields and spreads. Four, the huge divergence between the Fed and the ECB stance, a priori has big implications for exchange rates. Any indication that this divergence might take more time to build, has an instantaneous impact in the opposite direction, pushing up the euro. The economic implications will take time to filter through but one is left with a feeling of increased uncertainty, about the strength of the US recovery, about the capacity of an economy to generate sufficient inflation and, importantly, about how markets would have reacted if the surprise had gone in the other direction