The Risk Of Higher 10Y UST Yields….

The risk of higher yields is not a chart-able affair.

The new market paradigm is emerging :
The Fed is concerned only about short term rates and has commited to keep them low even if they taper.

This has left the 10Y UST in a limbo which is not at all alarming because we know that the Fed owns MORE THAN 50% OF ALL OUTSTANDING TREASURIES 5Y AND ABOVE. And the paradigm has worked out that the 2-10Y difference must keep widening, heading to its year highs at 2.5% (10Y at 2.785% and 2Y at 0.285%)

The 5Y high for the 2-10Y differential is 2.91% back in Feb 2010 when we were in the midst of QE1 which ended in June to be resumed in August 2010. Things are more predictable now with QE3 and with the Fed holding on to most of the stock.

Thus the logical outcome is for reduction in long end holdings as a hedge for the taper. Market positioning suggests that we are perhaps on the brink of the exodus, particularly if this Friday’s US employment report, the Non Farm Payrolls, shows further signs of strength.


Revisiting 3% in 10Y yields is an inevitability that most have not prepared for. In addition, the impact of a taper on EM markets will double the blow. For it is estimated that if the 10Y yields rise another 0.1-0.15%, EM currencies could weaken by some 2%, a reality that many smaller central banks have not adequately prepared for.

With the taper, the hunt for yield should continue as the trading maxim prescribes which is ingrained into every corporate bond sales pitch. That credit spreads will compress when the govi yields rise which, in reality, only holds true for investment grades and not so much for the high yields who will run into funding and re-financing issues and rising interest costs to eat into their income.

Instead of sitting and praying for a weak jobs number this Friday which will bring about only temporary relief into the next number in the next month, or the FOMC on 19 Dec. For it would appear that central banks have grown genius enough to realise that they are dealing with a 2 pronged problem of consumer price disinflation that is accompanied by runaway asset inflation.

And that QE is actually deflationary as far as CPI is concerned – because the money never leaves the banks to go into work other than just a mad grab for yield and when money does not go to work, wages will not rise.

Again, we conclude that central banks are willing to risk higher yields in the long end and another reason to sell those 10Y notes. The only wall we will run into will be the supply side of the equation – UST supply especially if the fiscal side of the equation improves. 10Y bunds are finding support as Merkel pledges austerity.

But as far as US treasury bonds go, “Banks’ $1.8 trillion of the bonds now equal less than 70 percent of their cash, the least since the Federal Reserve began compiling the data in 1973.” Source : Bloomberg. The article stated that banks are moving back into credits, loans and floating rate products.

There is just very little reason to buy those 10Y notes, is there ?