Aside from escalating Greek and Russian fears another event is worth watching, the US 10 –year Treasury yield touched 2% earlier today for the first time since early January. The bounce in yields since reaching a low of 1.63% on 30th Jan is noteworthy and could reveal some interesting shifts in the market’s psychology, including:
1, The market’s expectations of the Fed: after the stunning US jobs report last week, the prospect of a 25 basis point rate hike from the Fed is now back on the agenda, after some expected the Fed to remain on hold due to global deflation fears.
2, The US could de-couple from the rest of the world: the 10-year suggests that the market thinks that the US’s economic strength could make it resilient to the deflationary winds coming from Europe. As 10-year US yields make multi-week highs, German yields continue to make record lows, which should weigh on EURUSD in the coming weeks.
3, Treasuries as safe havens: yields move inversely to price, so as US Treasury yields are moving higher, prices are falling. Interestingly, demand for Treasuries is falling just as the latest Greek sovereign crisis is heating up. Either US Treasuries are losing their safe haven appeal (see below) or the market is complacent about Greek risks (potentially).
4, US equities start to lose their shine: As the Fed gets ready to hike rates at the same time that the ECB is embarking on QE we could see investors follow the liquidity – ditch US assets in favour of European ones. The rise in Treasury yields could be another sign that capital flows may start to move across the Atlantic to Europe where not only is there liquidity, but there could also be more equity market bargains to be found.
Yields and the dollar:
Higher yields traditionally lend support to the dollar. After a stunning rally from July 2014 until the start of this month, the dollar embarked on a period of consolidation, however it looks like the rally is back on. After taking a stumble on Monday, the dollar index has broken above recent highs and may test prior resistance at 95.52 – the high from 25th Jan. Above here opens the way to 100.00 – the highest level in 12 years.
What about USDJPY?
This pair tends to have a close relationship with Treasury yields; however the US-Japan yield spread and USDJPY diverged from September 2014 – with yields falling as USDJPY made fresh highs. After a recent period of consolidation this pair seems to be moving back in line with the US yield spread, which could fuel another move back to 120 and beyond. …
We think that a fresh USDJPY rally could be more potent if it moves in line with US Treasury yields, and if the 10-year yield can make gains above 2%, this could be bullish for USDJPY.
Although we feel strongly that the US could de-couple from the rest of the world, we are not convinced that US Treasuries are no longer considered a safe haven, so are concerned that yields could reverse their recent uptrend if the Greek crisis steps up a notch. If that happens and yields fall then we would also expect USDJPY to struggle as a flare up in sovereign debt fears could also drive inflows into the yen. For now US assets may be able to shrug off European fears, but if we get to the end of this month and there is no bailout deal for Greece then we believe that US assets will succumb to overall risk aversion and USDJPY could find that upside is limited.
- 10-year Treasury yields touched 2% today, which is a symbolic level of resistance, if we continue to see gains this could boost the dollar.
- The rising 10-year yield suggests that the US is de-coupling from the rest of the world and that a Fed rate hike in 1H 2015 is back on the agenda.
- Higher yields could also signal some capital flow out of the US (where monetary policy may tighten) and to Europe (where monetary policy is loose).
- Higher yields could boost USDJPY, and 120.00 is the next major psychological level of resistance.
- But, we don’t think yields will continue to rise if Greece doesn’t get an extension to its bailout, which expires at the end of this month. If that happens then safe haven flows into Treasuries could depress yields and weigh on USDJPY. Hence we are cautiously bullish at this stage until we get more details on what will happen in Greece.