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The October 4th low in 10-yr Treasury yields (1.71%) was not only an all-time record low, but it also signaled the reemergence of the bond market vigilantes (finally!). In the past two weeks, 10- and 30-yr Treasury yields have soared by 70 bps. For those who owned the long bond on October 4th, this resulted in an almost 13% loss of value. For those who bought equities on October 3rd, this has resulted in an almost 17% gain. Wow. The action of the past two weeks far eclipses the bond market rout that occurred in late June 2003. Back then it took the bond market a full month to push 10-yr yields up 70 bps. It also eclipses the dramatic reversal in yields that occurred at the end of 2008, when it also took a full month for 10-yr yields to rise 70 bps from their closing low of 2.05% on Dec. 30, 2008.
What looked to many like a great defensive play against an end-of-the-world scenario just two weeks ago now looks like a very expensive mistake. And why? All because Europe may have figured out a partial solution to its sovereign debt crisis. Not a full solution by any means, merely a step in the right direction. I think this vindicates my oft-repeated claims that the market was priced to a catastrophe, and anything short of a catastrophe could prove to be very bullish for equities and very bearish for bonds.
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Here's a chart of 30-yr Treasury yields (weekly) that shows how the recent reversal is very reminiscent of the reversal that followed the plunge in bond yields at the end of 2008. Both periods were marked by extreme levels of fear, panic, pessimism, you name it. If we follow the same pattern in the months to come - if the policy and economic fundamentals continue to improve even just slightly - then yields could rise much more, and equities could enjoy a truly spectacular rally. In short, this market is not being driven by optimism, it's being driven by the realization that the outlook is not nearly as bad as many had feared.