Aug 18 2014 - Rate Brief
A hodgepodge of global growth concerns and geopolitical headlines has made for some interesting times in the fixed income markets. A technical recession in Italy, and quarters of negative growth in Germany and Japan have developed at a time when global trade hangs in the balance over a debate of sovereignty in Eastern Europe.
In the United States, the Federal Reserve has tapered its asset purchase program to $25 bln per month amid talk of a strengthening economy and the belief that rate hikes will come in 2015. As growth slows around the developed world, the U.S. is now viewed as the cleanest dirty shirt, and that is evident by the US 2Y recently hitting 0.550% for the first time since May 2011.
Despite most believing rates would rise in 2014, longer dated U.S. Treasury yields have pressed to their lowest levels in 13 months. The US 10Y finds itself at 2.345% after starting the year at 3.028%. Now questions are being asked as to how low rates will go. In our opinion the move to the downside has nearly run its course, and the next major move is up from here.
Our focus has been on the long end, where the 30Y has pressed lower by 85bps to 3.135%. The yield on the long bond looks to be putting in the finishing touches of a five-wave decline off the closing levels of 2013. We believe now is not the time to establish new longs, and instead this 3.05%/3.15% area should be used to exit those positions as trade attempts to put in a tradable bottom.
Recent buying has the yield nearing the key 61.8% retracement of the run up in yield that began in July 2012 and culminated on the final trading day of 2013. This key Fibonacci level has marked a bottom for several moves over the past decade, and the corresponding bounce has caused yields to retest their previous highs. This suggests a move back up into the 4.00% area some time before the end of the first half of 2015.
Further evidence for a rise in yields comes with 2014 being a mid-term election year. The last several have produced a rally in yields beginning in the months leading up to the election. The tamest rally came in 2002 (55bps) while the most severe occurred in 1998 (200bps).
This also means the flattening of the yield curve is coming to an end.