Ten and five year US treasury notes made daily-scale compressions last week and moved down, as did Euro bunds a day earlier. Charts:
This comes at a time when weekly-scale compressions have also formed in all of these instruments, and in thirty-year bonds too, meaning that a bigger move is imminent after largely trendless trading since May:
Today is a turn day in US Bonds and so we might expect a break to happen very soon. Which way? Compressions are knife-edges from which the market may go either way with equal probability so we must either wait for the break (the sensible option) or speculate which way that break might go from other available information. Let’s try, using our own peculiar approach:
The program of money creation going on around the world creates cash out of thin air which is then used to buy assets in the marketplace. It targets interest-bearing instruments - mostly government bonds but also some others, such as mortgages. The intent is two-fold: firstly to put liquid funds into ‘the system’ as a general help in these troubled times and secondly to raise the prices (and so depress the yields) of these notes, bonds and other instruments. This is seen to be a good thing as it makes new borrowing cheaper.
This has succeeded in pushing bond prices very high, aided by a tendency for ‘flight capital’ to buy the bonds of the US, UK and Germany, despite their own governments’ worrying indebtedness. Yields are indeed now very low but this (probably) hasn’t helped achieve much economic growth because everyone remains too scared to invest. It can’t be said how much worse things might be without these programs, but is probable that they have done some good at the risk of storing up big trouble for the future (see the 28th September edition for our ‘take’ on this).
Interestingly, these bond markets have not risen any further since May, despite lots of money being created in that time and plenty of paper bought with it. There are two logical possibilities, now that these big compressions have developed:
1. This immense program of buying is being met by an equal amount of selling (obviously, as prices are stuck) and so is no longer able to push prices higher. The buying is largely fixed in size but the selling may increase, and this would/could be triggered by a slight slide in prices - potential sellers may panic and get more aggressive.
2. The immense program of buying has ‘mopped up’ all the potential sales that may come from the marketplace and, although there is a balanced situation at present, a little bit more buying will produce a sharp rise in price – this is the ‘marginal’ effect that makes commodity prices so volatile.
Each argument is plausible although we slightly favour option 1, observing that other asset prices are also a bit weak right now and no amount of liquidity will keep prices artificially high indefinitely, in any market. The conclusion? A big move is coming but still we should wait for the break. The lowest-risk tactic is to short-sell any small rally that takes prices up near those daily-scale compressions in the first charts, with a buy-back and reverse-into-long stop order just above the weekly compressions shown in the second group.