For the purposes of this article, I’m referring to the most commonly quoted US fixed income instrument-the 10 year Treasury note yield. The yield dropped to a record low in 2012 (July closing low was 1.49%) and has inched higher over the last 6 months to 1.88%. ‘Long the US bond market’ (akin to short yield) is undoubtedly a crowded trade. The public, investment professionals, pension funds, etc. piled into the bond market at the highs after ignoring the rally for most of the last 3 years. Such activity is characteristic of a market turn.
‘Has the bond market topped?’ isn’t as important a question however as ‘at what level would the market inflict the most pain on the most participants?’ In other words, when do increasing yields (declining bond and note values) become a story and what would the implications be for the FX market?
10 Yr. Treasury Note Futures
Prepared by Jamie Saettele, CMT
Speculative positioning on 10 year Treasury note futures highlights the herd behavior that governs all markets. The majority finally bought (literally) into the trend of rising treasuries (declining yields) at what is so far the top. Such activity is consistent with a significant turn.
10 Yr. Treasury Note Futures
Prepared by Jamie Saettele, CMT
In order to gauge the level at which increasing yields (declining bonds) become a story, we need to find where the most activity took place. A record futures volume was generated in August 2011, so the August 2011 close (the closing price is viewed as most important) is the obvious candidate for our ‘critical level’. The August 2011 close was defended in March 2012, which ended up being the low for all of 2012. It’s comforting that the market has validated this level as one of importance. The corresponding level for yields is 2.22% (see next chart). 2.22% is the point of maximum vested interest and therefore the level that many may decide to exit the bond market (and send yields higher). If this happens, then expect extreme intraday market moves across major markets, especially the USDJPY.
Prepared by Jamie Saettele, CMT
USDJPY and US 10 Yr. Treasury Note Futures (Inverted)
Prepared by Jamie Saettele, CMT
It is well documented that currency markets ebb and flow with the change in yield differentials (the cost of money). Decreasing yield differentials in recent years, especially in 2012, can be cited for the lack of trends in USD based pairs. If yields continue to tick higher, then expect trends to reappear. The USDJPY has already broken out but increasing US yields would intensify the move and shift focus to the 2010 and 2009 highs at 9500 and 10144.