Several extensions occurred on Friday in US Treasury instruments. The five and ten - year note yields both extended, as did the prices. We are always a bit more impressed by signals from the yield series than by signals from prices as they provide a better continuous history without the need to splice together sequential futures expiries. Thirty-year bond prices also extended. Prices and yields move in opposite directions, for those readers who are only used to seeing prices:
It was also a turn day in the bond and note markets, and this combination means that we now advise taking long positions immediately. We also have some observations:
1. The reaction to the Fed Chairman’s attempt to reassure markets last week has been to extend the rise in 30-year bond yields to a new recent high of 3.57% from 2.8% only seven weeks ago. The all-time low was around 2.5% made in 2008 and equalled in mid-2012 and so current yields now represent a real return over the (less than 2%) rate of inflation. This is less true of the ten-year yield which is now 2.51%, up from an all-time low of less than 1.4% last year and not true at all for five-year yields which are now 1.41% after a low of almost half of one per cent. Some charts, just to illustrate yield movements over the last few years:
Because of this rise in yields there is now some ‘value’ in longer-term bond yields compared to short-term rates, which are almost zero. This will tempt some buyers and probably 'flatten the curve' in weeks to come, that is reduce longer-term rates relative to those of shorter-term instruments.
2. The Fed Chairman made an impromptu remark during his press conference, revealing that he thinks it is more important that the Fed now owns a large amount debt securities than the future pace of any more buying. This is one of the aspects of QE that we mentioned in our February 22nd edition, we agree that this large holding is supportive of bond markets (for reasons given then) and it adds force to our recommendation to take new long positions in bonds now.
3. That which supports bonds does not necessarily support stocks and most of the recent rise in equity values has been caused by the new cash created by QE. The aggregate amount of treasuries held is mostly irrelevant to the equity market but the amount of new buying is very important so any ‘tapering’ of QE may be neutral for bonds but is definitely bearish for stocks. As stock markets are priced almost entirely on expectation, the prospect of a reduction in new cash coming into existence has been enough to remove the underpinnings of the recent rise and more stock market declines are highly likely. We have already advised that we are bearish in the medium and longer-term of the prospects for US and European equity markets.
Be long bonds, short stocks.
Much of this bearish argument for stocks (the prospective end of new money creation) also applies to commodities of course, and we have already expressed our bearish views in recent editions.