"Attached is the latest Review and Outlook from Hoisington Management. I think you'll find it quite provocative and a good counterpoint to the renewed bearishness in the bond market. To wit, Hoisington points out that 2% long bond (30 years) yields are quite common in an environment where there is an excessive accumulation of debt. From current yields, that would represent a 30% increase in price - worth pondering as investors rush back into 0% cash".
Eoin Treacy's view Thank you for this succinct report which lays out the case for why Treasury
prices may stay higher for longer. Here is a section:
Although many measures of economic performance worsened during QE2, the Fed might argue that the recent M2 acceleration may eventually contribute to an improvement in economic growth as deposit growth fuels income expansion. In our opinion, such an optimistic assessment is not warranted.
In the past three months, M2 increased at a rapid annualized pace of more than 20%, and the annual increase in M2 is about 10%, well above the post 1900 average annual increase of 6.6%. this rise in M2, however, appears to reflect a massive balance sheet shift of assets, not a net creation of new assets. Theoretically, if funds are switched from non-M2 assets into M2 assets, M2 velocity would decline and bank loans plus commercial paper would be stable. This is exactly what has been happening.
After peaking at 1.69 in the second quarter of 2010, M2 velocity declined for four consecutive quarters, and we estimate that a major contraction in velocity to 1.59 is likely for the third quarter (Chart 3). Also supporting this idea of asset shifting, bank loans plus commercial paper in
September totaled $7.845 trillion, down from $7.906 trillion in June 2010.
US economic growth remains sluggish. The banking sector is still under pressure. Foreclosures have probably peaked but more than 200,000 a month is still a sizeable number and a recovery in house prices nationally will take time. Add economic policy uncertainty, central bank meddling, high unemployment and deteriorating sentiment and it is not difficult to understand why some remain bullish of long dated bonds. I last reviewed government bond prices on Tuesday but I will focus today on yields.
2% is an ambitious target. 30-year yields hit a significant low at 2.5% in 2008 and a near term low of 2.69% on October 4th. On both occasions yields accelerated lower. At The Chart Seminar we define acceleration as a trend ending of undetermined duration. The more abrupt the acceleration the quicker it expends the available supply and the greater the chance of a snap back in the other direction. This does not tell us how far yields are likely to rally but does stack the odds in favour of a rally.
Yields have now rallied for 7 of the last 8 sessions. Today's Treasury auction will have been anticipated by primary dealers so there is potential for a partial retracement of the short-term advance. However, when we look at the medium-term, yields are deeply oversold. Even if one assumers a bearish overall environment, there remains scope for a more substantial rally which could unwind the oversold condition relative to the 200-day MA, currently at 3.86%. Long-term, the almost 30-year progression of lower rally highs remains intact and a sustained move above 4.75% would be required to conclusively indicate trend change.
10-year yields dropped below the 2008 low but have steadied and the likelihood of a reversion towards the mean has increased. A sustained move below 1.7% would be required to reassert the almost yearlong downtrend.
UK 30-year yields have trended steadily lower for most of the year and broke below the psychological 4% level in July. The two-week rally is now challenging the progression of lower rally highs. While overextended relative to the 200-day MA, a sustained move above this week's high, at 3.6%, will be required to signal that more than a very short bounce is underway.
The UK 10yr yield broke below 4% in 2008 and has subsequently encountered resistance at that level on a number of occasions. It has rallied to the upper side of the two-month range and has at least partially unwound the oversold condition relative to the 200-day MA. However a sustained move above it, currently near 3%, would be required to question the consistency of the medium-term downtrend. The Canadian 10-year and the Swiss 10-year have similar patterns.
German 10-year yield collapsed from 3.5% to a low of 1.63% between April and four weeks ago. This was a persistent decline fuelled by demand for a safe haven asset as fears about the sustainability of the Euro increased the relative attraction of German government liabilities. Yields of 1.63% can be considered to equate to a worst case scenario and as this becomes a less likely prospect, yields have begun to unwind their oversold condition. A clear downward dynamic would be required to question current scope for some additional upside, while a sustained move above 3.5% would be needed to question the five-year progression of lower rally highs.
The Australian 10-year yield retested its 2009 low in late September and also appears to be unwinding the short-term oversold condition.
All of the above yields are unwinding short-term oversold conditions. This could potentially mark a medium-term bottom. If they find support above their respective lows on the next pullback and subsequently extend their rallies, the relative attractiveness of the asset class will be questioned. Sustained moves above their respective 200-day MAs and where relevant back up into overhead ranges would likely require catalysts in the form of significantly more optimistic economic perceptions.