Jan 22. (bond yields) breaking with the past
Short note this week, mostly in the form of a question, “could yields now be in a bear market?”
Above is a chart of 4 bond yields, US in blue, UK in white, Japan in red and Germany in green. I used the Japanese 30 year yield as the ten year JGB is being targeted by the BoJ, holding around 5-6 bps. Since Q3 2016, all these yields bottomed and have been moving higher. The German bund closed on a new high of 42 this week. The 30y JGB is also right at the high, 80 bps. In the US, Bill Gross has talked about 2.60 as the level above which we will be in a confirmed bear market in bonds. Gundlach has mentioned 3%. The latter level was last reached at the end of 2013, the year of the ‘taper tantrum’. On the chart above, it clearly appears as if 3% is a big hurdle to overcome. In the UK I would say a close above 2.1% would be the level. In Japan, 1.5% and in Germany 1%. Of course, Q2 of 2015 also looked like a break out of yields, especially as bunds exploded. However, there are differences this time, including accelerating measures of inflation expectations and.. . the Donald.
Of course, there are still many bond bulls out there, including Lacy Hunt who received a reasonable amount coverage with latest call, unsurprisingly, that yields are going lower. His track record on lower bond yields has been unwavering, his reasoning completely on target.
The question is, could we be in the midst of a turn now? Hunt points to the low and declining velocity of money as evidence that rates can continue to decline.
However, part of this decline is related to the numerator, M2, which had been at a fairly stable growth rate of around 6% from 2015 to the beginning of 2016, but accelerated as the year went on and closed 2016 around 8%. https://ycharts.com/indicators/m2_money_supply_growth
What if velocity also begins to turn from here? Could inflationary expectations start to get away from the Fed? It’s not completely uncommon. From the end of Dec 1986 to end of Sept 1987, yoy CPI went from 1.1 to 4.4. March 1999 to June 2000 it went from 1.7 to 3.7. June 2010 to Sept 2011 from 1.1 to 3.9. And currently, from Sept 2015 to Dec 2016, from 0.0 to 2.1….so far.
This week Yellen said the economy was strong enough to withstand rate hikes, and there were also a few comments (Harker) about shrinking the Fed’s balance sheet. However, the peak one-year calendar spread on the Eurodollar curve is only 56 bps (EDH7/EDH8) and most are below 50 bps, suggesting only two rate hikes per year. Last week I mentioned the flatness in the curve and noted that the red/gold Eurodollar pack spread (2nd to 5th year) closed at a recent low of 71, citing this level as the halfway point from the Sept 27 low of 41 to the Dec 12 high of 101.5. This week we bounced and closed 81.625.
News is fairly light this week, with auctions of 2’s, 5’s and 7’s. Feb treasury options expire Friday. The first 100 days of the new administration arrives at the end of April; there is an FOMC meeting on May 3.
