The size of the market in outstanding, longer-dated bonds is too big for the U.S. Fed to hold sway over prices and bond yields in the longer term. Out of the US$14.3 trillion of U.S. Treasuries outstanding, US4.6 trillion are non-marketable, held by intra-government entities. Of the balance of US$9.6 trillion, about US$2.2 trillion are four- to eight-year maturities and another US$2.2 trillion is spread over nine to 30 years. If bond investors expect the economy to continue to gain strength, yields will rise (and bond prices will fall even with the Fed as a bond buyer). But if investors expect the economic recovery to stall, yields can drop, and prices can rise even without bond purchases by the Fed.
So, with 10-year bonds at 3.3%, what is the current yield curve telling us in terms of what bond investors think? We believe it suggests expectations of slow growth and probably no QE3. Bond investor expectations are thus at divergence with equity investors as the rally on Wall Street is riding on hopes of robust growth rates. If bond investors are right, Wall Street is still overly optimistic. Until recently, Wall Street expectations were for 4%+ growth. That has now been trimmed to nearer 3%. A bit more trimmings would be healthy. U.S. bond yields offer a sensitive indicator on growth expectations and sentiment surrounding the dollar, one of the more useful sign posts to gauge future market directions.
Eoin Treacy's view US Treasuries have rallied impressively over the last month as investors speculated on how the Fed will end the latest round of quantitative easing. The approaching deadline may also have helped support the US Dollar as the wave of newly issued Treasuries will soon crest. Multilateral intervention to weaken the Yen and resurgent Eurozone sovereign debt issues have also contributed to a somewhat firmer tone for the US Dollar of late. The pullback in commodity prices particularly in precious metals and energy may also be helping to spur demand for a "safe haven" at least in the short term.
US 30yr Treasury prices have paused below 125 for the last week, but a sustained move below 122.5 would be required to check scope for a successful upward break. A significant rally in Treasury prices would likely offer a favourable shorting opportunity in the context of the medium-term top formation.
The US Dollar Index has rallied to test the five month progression of lower rally highs and a sustained move below 74 would now be required to check potential for some additional upside.