A Fed rate hike likely before year-end

If we do get to the point where the Greek crisis is behind us one way or another, the next likely major challenge for European equity markets will be Fed tightening. While that may drive the euro down, it is not something that is normally conducive to European yields heading lower. The market has downplayed the risks with only an 80% likelihood of Fed  tightening priced in to the curve over the balance of this year post the payrolls report. 

"Our US economists, supported by various Fed speeches, still think September is a distinct possibility. Even if that were to be missed, they expect a hike before year-end because they believe the hurdle to lift-off is not that high. Having said that, when the Fed does move, the market is not expected to reach 2% Fed funds before mid-2018 - a modest pace of tightening indeed," says BofA Merrill Lynch.

Investors would likely price a faster pace of tightening should the Fed move this year, elevating the risk of a sharp rise in Treasury yields to a real one. The lessons of the "bund shock" are that in a bond selloff, the lack of liquidity can amplify the normal moves. Should we suddenly find the 10-year yield moving through 3%, it would be bad news for equity markets.