I read somewhere that when the U.S. Treasury yields rise, it will also have a "gravitational pull" on yields of other sovereign debt markets. For example, when the U.S. Treasury yields rise, the German bund yield will also rise. Is it because when US yields rise, sovereign bond investors will move out of lower yielding Eurozone sovereigns into US Treasuries? Can someone please explain the relationship or transmission mechanism?
For free-floating sovereign borrowers (e.g., Japan, Canada, UK, and the euro as a bloc (the member countries are pegged versus each other), short-term bond yields are largely determined by the expected path of the policy rate (plus a small term premium).
For longer-term bonds, one can debate how value is determined, but forward rates are generally smooth, so they can be interpreted as rate expectations and a term premium as well.
This means that bond yields ca diverge: e.g. look at Japanese bonds versus other sovereigns from 1995-2008 (at which point other countries converged at levels near Japan’s).
However, we see correlations between markets, which is not unexpected.
- Central bankers might set domestic rates as a spread versus another currency, like the USD.
- The business cycle is global, and new information about the outlook is thus correlated across markets.
This explains why short-term movements often are in the same direction, yet there are no reliable “rules” (since that would imply guaranteed trading profits).
Yes. What you say is correct: if US bonds have a higher yield then investors will choose to invest in US bonds, but then when Germany or Japan or any other country needs to issue debt, they will have to set a higher rate to attract investors to buy their bonds.
Of course, we are talking about changes in the interest rate, not in the level of the interest rate, which will depend on the country premium risk (Argentina and Venezuela pay much higher yields for their debt).
However, this "gravitational pull" is true under a ceteris paribus condition: each Central Bank has different a monetary policy and the determination of the interest rate will also depend on future inflation expectations, for example.