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For over two months, long bonds have been marching relentlessly lower, breaking key support at 106.50 last Friday. The next downside target is the Jul 06 lows at 104 (which equates to 5.25%).


click to enlarge

10 yr bonds breaking below support

Here’s where is gets curious:

The news last week was decidedly negative, weaker than expected 1st quarter GDP growth and a string of layoffs at some of the nation’s biggest employers (Dell (NASDAQ:DELL), Pulte Homes (NYSE:PHM) and IBM (NYSE:IBM)).

That’s a sign growth is slowing right? That should be bullish for bonds. As price inflation fears subside, bonds should rally. Hell, even gold buys that story and has been moving lower since early May. So what’s happening? Why are bonds tanking?

I know markets discount the future and that news is effectively ancient history. I’ve been saying for a while that there are intermarket forces at work pulling bonds lower and forcing yields higher. That force is a declining US dollar, where bonds have been following the dollar lower with a 2 to 3 month time lag. [The US dollar bottomed in late April so we have at least 1 more month of bond weakness ahead.]

But that still doesn’t answer the conundrum, why are interest rates rising in the face of a slowing economy?

By the way, since February, the short end of the curve has been dropping precipitously. The yield curve has widened substantially, even righting itself from its previous inversion. Investors are voting with their wallets and they’re saying the Feds next move will be to cut interest rates in response to a slowing economy.

So if short term interest rates get it, why don’t long rates?

I think they do.

Nikkei Weekly

The major holders of long-term US bonds are Japanese investors. A slowdown in the USA is causing Japanese investors to sell US bonds (raising rates) and repatriate their funds back home to invest in Japanese stocks with offer more promising prospects. More promising because Japan is a net exporter and the weak Yen is a boon to Japanese Corporations.

The upshot for gold investors (as the above chart shows) is that gold is very closely tied to rising Japanese stocks. Interest rate sensitive banks and housing stands to be the most negatively effected.

A slowdown in growth is causing a shift out of US long-term debt into the Nikkei and by correlation into counter-cyclical gold. Expect the above trends to remain in place for some months yet.

Source: Why Falling Bonds Are Good For Gold