The market came into the week with a big focus on the scheduled policy announcement from the European Central Bank (ECB). While our focus remains on mortgage rates in an entirely different continent, major goings on in European markets almost always have an effect on the equivalent U.S. markets.
That would prove true on several fronts by the end of the week. In addition to the ECB announcement, markets also reacted to big shifts in European economic data. When domestic data sang a similar tune, rates were moving sharply lower by Friday.
To understand why the ECB or economic data matter to rates, we first need to remember that rates are primarily determined by the trading levels in the bond market. The 10yr Treasury yield, for instance, is a prime example.
Next, we should consider that bonds in the US have an interconnected relationship with overseas bond markets--EU markets being the most notable in terms of correlation. In other words, when something causes a huge move in EU bonds, we tend to see a smaller version of that move in the US.
So what do bonds care about and what makes rates go lower?
Bond yields (aka "rates") move lower as demand for bonds increases. Economic weakness is one reliable way to create more demand for bonds. A weaker economy helps ease demand side inflation pressure (inflation is a key enemy of low rates). It also prompts investors to seek safer havens--investments that won't lose a lot of money if the economy continues to contract--and the bond market is the quintessential safe haven.
Data aside, big policy changes from central banks--like the Fed or the European Central Bank (ECB)--can have immediate implications for bond demand. In this week's example, the ECB unveiled a new bond-buying tool that promised to add a bit of demand. This pushed European yields lower. US yields followed at a slightly less aggressive pace.
Additional bond buying demand was seen in the wake of several rather downbeat economic reports, with the best examples arriving on Thursday and Friday, both in Europe and the US.
