In a previous article in March 2012 I pointed out that it was the perfect time to get out of U.S. bonds and go into eurobonds. Just recently we have a huge confirmation that the market is favoring European bonds over U.S. bonds (Chart 1). We see that the WisdomTree Dreyfus Euro ETF (NYSEARCA:EU) has shot upwards on 21 August 2012 on news that the ECB would buy Italian and Spanish bonds. That day, the euro jumped to a seven-week peak against the U.S. dollar.
As a said before in the March article, it is very important to watch the currency markets for the euro and the U.S. dollar. If the exchange rates favor for example the euro, then the market will lean towards buying European bonds instead of U.S. bonds. On Chart 2 we can see that the euro has started to behave positively based on a recent ECB decision that there will be an unlimited buying of European bonds with a maturity of 1 to 3 years. Based on chart 1, we can see a very symmetric pattern until August 2012. In August, the red chart went up a lot, while the blue chart hasn't declined at the same rate. To me, this indicates that U.S. bonds values will fall sharply in the short term, while bond yields will rise. A week ago, Ben Bernanke didn't confirm that the federal reserve would take action for a further QE3. He mentioned that a round of bond buying was an option, but there are no concrete plans yet. This basically confirms that a rise in U.S. bond yields is very probable.
The market has already anticipated the news about the bond sterilization action of the ECB as we can see that Italian (Chart 3) and Spanish (Chart 4) bond yields have declined sharply.
U.S. bond yields (Chart 5) have not kept pace (yields have not risen) with the rise of European bonds according to the correlation in Chart 1. This means investors should take action and go short U.S. bonds. They can buy the Proshares Ultrashort 20 year treasury ETF (NYSEARCA:TBT). Moreover, the U.S. total national debt has crossed the $16 trillion mark and is quickly approaching the debt limit at $16.3 trillion. This is obviously going to be a negative for U.S. bonds going forward. Additionally, Ben Bernanke only hinted about a bond buying program at the Jackson Hole meeting a week ago, so no real actions were confirmed.