Macro Wrap – The Bullish Treasuries Argument is Picking Up Steam

by Enis October 18, 2013 6:56 am • Commentary

Quietly and without fanfare, interest rates in the U.S. are making multi-month lows this morning.  The 10 year yield is at its lowest level since July, nearing the psychologically important 2.50 level:

10 year Treasury Yield, Courtesy of Bloomberg
10 year Treasury Yield, Courtesy of Bloomberg

The more relevant level technically is around 2.35-2.40, shown in red, which was the high in the 10 year yield in late 2011 and early 2012, and the breakout area in June of this year.

The bullish Treasuries argument is picking up steam, with several oft-cited reasons:

  1. Tapering by the Fed Pushed Back – expectations are now for tapering to begin in 2014, with many market participants pushing back the date to mid-2014 after the political calendar that was set this week in the budget resolution.  Since politicians are once again going to be debating the debt ceiling and the government budget in early 2014, the Fed won’t feel comfortable tapering until that’s resolved.  Of course, there will always be something, but the Fed hardly seems to be in a rush anyways.
  2. Reduced Treasury Issuance – The U.S. budget deficit has shrunk since the Fed first decided to buy $85 billion of bonds per month (between Treasuries and MBS).  So while supply has dwindled, Fed demand has remained the same.
  3. Growth Not Gangbusters – Not strong enough to cause concerns about tapering.  Jobless claims have surprised to the upside in the past 2 weeks, and economists have ratcheted down 4th quarter expectations due to the 2 week government shutdown.
  4. Sentiment / Positioning Provides Tailwind – Portfolio managers are still very underweight bonds in their portfolios, as Ukarlewitz pointed out in his analysis of the BAML survey of global fund managers.

The fall in U.S. rates has especially boosted the demand for emerging market assets.  EM currencies and stocks have outperformed in the past 6 weeks, after experiencing a rough summer following the global tightening that occurred on fears of tapering.  Rates are still higher than they were 6 months ago, but the trend has changed.  Watch the 2.35% yield level on the 10 year as the inflection point for a more dramatic shift in the Treasury market.