Does The Bond Market Have A Message For Currencies?

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Includes: FXB, FXE, FXY, UDN, UUP
by: Ralph Shell

Most of the attention this week has been focused on equities and their persistent push to the upside. Some days there is a decent upside run, and on others the market barely squeaks out a gain. Despite some worries, however, the market continues its climb.

As equities climb, U.S. Treasuries have been selling off, thereby increasing the yield. Going back to the last day of February the yield was then .29% on two year paper, 1.97% on 10-year and 3.10% on the 30-year bond. Today March 16th the rates have gone up to .37 on two year paper, 2.33% on the 10-year and 3.44% on the long bond.

The increase in rates is not confined to the U.S. shores. During the same period, in Germany the 10-year bund yield has gone up from 1.85% to 2.05% late today, and the British 10-year has gone from 2.14% to 2.45%. Even the Japanese 10-year notes, which have been under 1% seemingly forever, have appreciated to 1.05%.

The CPI Data released today in the U.S. may have given the Treasuries a further nudge to the downside. The core CPI which excludes food and fuel was only up 0.1%, but in the real world where people have to buy food and energy, the CPI was up 0.4%. The release of this data caused a sell off in the U.S. dollar versus the pound, euro and the yen.

For weeks the U.S. fundamental data had been positive, suggesting the recovery is on track, but there was contradicting reports today. Not an important report, but M/M U.S. Industrial Production was unchanged, down from the expected positive 0.4%. This was followed by a University of Michigan Sentiment Report which showed a drop in consumer sentiment.

High energy prices are in the middle of both the real CPI numbers, the ones that include everything you buy, and no doubt cast a negative to the consumer sentiment report.

The United States has a wealth of possible energy supplies but the current administration has obstructed development. The result is a yearly balance of payment deficit, about $320B for energy alone, to pay for energy which the U.S. has but is forbidden to develop. An example is oil about 30 miles from Key West where U.S. companies cannot drill. This has not stopped the Castro brother and their Chinese friends from drilling there.

Contrast this to Ireland, 30 kilometers off shore from County Cork where Irish drillers reported their first well tested about 3,500 bpd of light crude and another 500 barrels of liquids. It is in shallow waters, only 100 meters, and the sand formation is 4/7000 feet so it should not be a real costly well. The developer thinks it is about the size of a small North Sea field. Time will tell.

Energy is a story for another day. Our concern today is the bond bubble. Is it ending and will it have an influence over currency relationships. We have some observations, after looking at the weekly charts for the euro yen and the pound.

Trade in the euro pleased no one this week. The euro bulls were able to keep the trade out of the 1.20's, and it subsequently staged a rally. Should the bond bubble get worse, and the rates work higher, the euro is probably the most vulnerable. ECB President Draghi wears too many hats and has too many countries to please. Further the amount of sovereign debt that needs to be rolled over is huge.

Longer term the yen is most vulnerable, but for the moment the BOJ is getting what they want, a weaker yen. We wonder though, after six weeks of severe weakness, is this enough of a sell off?

Of the three majors versus the USD, the pound looks the strongest. The pound, like the euro, has a big spec short open interest. We will be following the pound next week, possibly looking for a spot to buy.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.