Photo: AFP
Photo: AFP

Political shocks have intruded into the global pricing of duration in a way that I have not previously observed. The main risks clearly are Italy and trade war, although that does not quite exhaust the list; President Trump’s tantrum overnight may explain the strange behavior of duration markets.

The tail wagged the dog again overnight as the 10-year Bund led the US 10-year Treasury.

Bunds lead Treasuries

Unusual as this is given the relative size of both markets, it has been happening all year. Bunds reprice after political shocks and Treasuries follow.

US vs German linker GARCH vol
Bund vs US 10-yr futures volatility

This is a very odd development and out of line with what we normally would expect.

Nonetheless, the more we drill down into the data, the more the political risk component pops out.

Here is a Principal Components Decomposition of the group of 10-year notes. Note that the 1st (systemic) Principal Component has opposite signs for the US and Germany. In fact, the US and Italy have the same sign for both the 1st and 2nd Principal Components.

Principal components

Note that the same Principal Components Decomposition for calendar year 2017 shows the expected values: all the members of the universe have similar exposure to the 1st Principal Component.

Principal components 2