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The Bond Column

Yields and Dollar Jump
Updated: 2016-10-17, 08:55:36 ET
Analyst: David Kelland

Long-dated Treasury yields kept moving higher this week withthe 30-year yield pushing up 10 basis points to 2.56% and the 10-year yieldgaining five basis points to 1.79%. Both of them are now above their 200-day movingaverages. There are technical reasons to believe that there is more upside inyields ahead. Initial resistance in the 30-year yield is at ~2.62%, the August2015 low and the downtrend of the decline in yields that began in January 2014.Those levels on the 10-year yield chart are ~1.90% and ~1.97%. (see chartsbelow)

The other trend that has been gathering momentum in Octoberis that the U.S. Dollar Index is up 2.8%. The weakest major currency againstthat dollar rally has been the British pound, which has suffered badly frommarket resignation to a U.K. future without access to the single market. Sinceroughly 16% of eurozone exports go to the U.K., the euro has suffered as well. Obviously, business within the eurozone will also have to compete with cheaperU.K. imports until the U.K. actually loses access to the single market.

A stronger U.S. dollar pressures the Chinese authorities tointervene more forcefully in USD/CNY or to devalue. The pair is currentlytrading at a six-year high and the steady drip of headlines about structuralproblems in the Chinese economy is accelerating. The timing of furtherdevaluation is almost impossible to predict, but it looks like an inevitabilitygiven the debt problems in the middle kingdom.

The higher-than-expected PPI growth announced on Fridayshows that inflationary pressures are slowly building in the U.S. Even if thereturn of inflation has been sluggish, it is much more sustained than anythingseen in Japan or the eurozone. That leads investors to believe that the Fedwill have room to hike rates at the December FOMC meeting and strengthens thegreenback.

The European Central Bank meets onThursday. The market is currently expecting a six month extension of thecurrent EUR80 bln/month asset purchase program to September of 2017. Anyindication that the extension will not materialize would be very bearish foreurozone government bonds and bullish for the euro. This is highly unlikely.

The ECB could tweak its current program to allowit to buy securities yielding less than the deposit rate (currently -0.40%) or,more controversially and so less likely, the governing council could decide toabandon the capital key which restricts the program to buying government bondsin proportion to each country's GDP. The latter move would compresscore/periphery spreads.

The ECB could refer to the probability of anextension of asset purchases or, less likely, even announce the extension. TheECB established a working group in September to review the asset purchaseprogram and to report back in December of this year, so it is unlikely that thecentral bank would take action before seeing the results of the review.

- David Kelland,

  • 10-Year Yield (Daily):

  • 30-Year Yield (Daily):