On Falling European Yields

Non-farm payrolls gave the US dollar a small lift on Friday but the big story was the drop in European bond yields. 10-year yields fell 5 to 20 basis points across Europe as the fallout from the ECB decision continues. Both Premium trades in EURUSD were filled and remain in progress, as is the long in USDCHF, with all details and 3 related charts found in the latest Premium Insights.

By any measure, yields throughout the continent are low. French 10s hit a record 1.66% on Friday.

Italian 10s are now yielding barely more than US Treasuries at 2.76% versus 2.58%. Italian 10s are down 60 bps since May 21 and have fallen in 18 of the past 23 weeks.

There are three ways to look at the tumbling yields.

First is that the ECB hasn't done enough to prevent deflation. The only way accepting that kind of yield for French debt makes sense is in a world with zero or negative inflation.

There's another way-- The details of the new targeted LTRO are out and it's not as 'targeted' as billed. The money is supposed to go to new lending for 4 years but the terms are vague and so is the enforcement mechanism. Banks could still take the extremely low-priced money from the ECB and invest the 400 billion euros in sovereigns to earn the carry.

Third is that negative deposit rates are forcing banks out of cash and down the yield curve.

Some combination of all three factors is the correct answer but whatever the reason, Europe is suddenly a place where it doesn't make much sense to park money. It will eventually flow into more risky assets or to higher-yielding safe havens.

At the same time, the crisis in Ukraine appears to be stabilizing after Putin met Poroshenko on Friday and both expressed a desire for peace. That could reverse some of the European-directed safe haven flows from the height of the crisis.

The euro jumped after the ECB decision but with yields so low, the threat of deflation, less Ukraine risk and a slight improvement in US fortunes in the non-farm payrolls report, it's tough to make a positive case for the euro.