is this what happens when the greenback fights the Fed?  Photographer: Andrew Harrer/Bloomberg
is this what happens when the greenback fights the Fed? Photographer: Andrew Harrer/Bloomberg

The U.S. government bond market has allegedly unshackled itself from the monetary policies of the Federal Reserve and is instead at the benign mercy of the European Central Bank. If that's true, no one told the U.S. dollar.

The Financial Times reported on Aug. 31 that the correlation between five- and 10-year U.S. Treasuries had dropped to a record low, with longer-dated yields dropping while those on shorter-dated maturities had barely budged. This suggests "the link between U.S. monetary policy and U.S. bond yields has fallen apart this year, showing how fears of deflation in Europe are driving global financial markets," the newspaper said.

Fed Tapers QE

And yesterday, Bloomberg News said "Europe is gaining more leverage over investors globally," in an article entitled "Bond Markets Tilt Toward Frankfurt as ECB Negates Fed Hawks." At 2.45 percent, down from 2.8 percent as recently as April and compared with more than 3 percent at the start of the year, the 10-year U.S. yield certainly doesn't seem to reflect any likelihood of the Fed raising rates or taking back the largesse it has supplied via quantitative easing.

It's a different story in the currency market, though, where the dollar has been roaring ahead to reach its highest since July 2013:

Source: Intercontinental Exchange via Bloomberg
Source: Intercontinental Exchange via Bloomberg

The currencies of countries anticipating higher growth, faster inflation and tighter central bank monetary policy typically strengthen; against that backdrop, government bond yields also typically climb. So right now either the dollar or the U.S. bond market has to be wrong. My money is on the latter: bond yields have become so unhinged from economic reality as to be meaningless.

To contact the author of this article: Mark Gilbert at magilbert@bloomberg.net.

To contact the editor responsible for this article: Marc Champion at mchampion7@bloomberg.net.