Last week, I discussed how rates should move higher in the Treasury market. Let us look into this a bit more this week.
We have seen rates on the U.S. Treasuries fall sharply this year and this has taken many of us by surprise. With the end of quantitative easing (QE) nearing, we expected rates to rise. Traders are now eyeing the exit as they are fearing a correction is on the horizon.
This Thursday, we are expecting the European Central Bank (ECB) will announce new easing measures and this has helped push Treasury yields lower in April and will continue to put downward pressure throughout May. The ECB decision on Thursday should mark a low point for yields as investors are buying into U.S. debt as ECB President Mario Draghi is signaling further monetary easing, including negative rates, to combat deflation. We must ready ourselves and increase duration in under-weights.
Another factor at play here is short covering which is being spurred by a bear squeeze. We are also seeing investors seeking safety of funds as there are geo political jitters. All of this is causing the price of Treasuries to rise, and since yield moves inversely, yields are moving lower.
Ten year Treasury yields hit an 11 month low last week at 2.44 percent. They have since edged higher back to 2.49 percent, testing a key resistance level, at 2.5 percent. Still, we remain way below the January high of three percent. There is a bull run on Treasuries in play now. This is worrisome because a sharp correction could come soon. Especially, even with the recent blip with a contracting GDP, the U.S. economy continues to improve. At some point, there will be a response within the inflation environment. This means the Federal Reserve (Fed) will have to move to normalize its rate policy.
Treasuries are expensive. With the 30 year yield near three percent and the 10 year yield near 2.4 percent, this indicating a strong risk to the upside is materializing. Especially with some solid numbers beginning to be seen in the U.S. housing market, durable goods orders and even in commercial lending.
Now could be a good time to cut back on duration which means returns in the long end, though the end of the year could turn negative. This also signals problems in both long and short positions in the Treasury market.
Treasuries are at a stage where insiders are starting to take profits on the long side. On the short side, we are seeing the panic stage take hold. This is the classic Minsky Moment1 which tracks assets and their prices through business cycles as they fall. It tracks assets as they become undervalued though macro shocks. This is then followed by expansion with gains driven by leverage, profit taking, liquidation of assets and panic.
Bottom line, now is the time to stand aside in the Treasury market.
1 "Minsky Moment," by John Cassidy, The New Yorker, February 4, 2008.
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