US10Y – Higher Yields Here We Come

Bond prices tanked after FOMC Minutes increased the likelihood of 2013 Tapering event. Unlike Stocks and FX, Bond traders were unanimous in their reaction, with 10Y Benchmark prices hitting lower without any significant pullback. This is because yields have been artificially depressed since the introduction of QE1 in late 2008. Without QE purchases, it is unlikely that yields will be this low considering that alpha gains from Commodities and Stocks have been much higher in recent years thanks to cheap financing. To put it in perspective, US 10Y yields has been historically much higher, with an average of above 5% since 1962. Furthermore, any Finance student would also know that textbook risk free rate (e.g. pure cost of borrowing money without any other risk factor) is traditionally set at 3%, making the yields of past few years looking highly unnatural.

Stocks and FX traders may be forgiven if they are unable to determine what is the final outcome for their respective assets in a world without QE. However in the case of Yields, the answer is clear cut, whether US market is able to come out stronger without QE clutches is irrelevant in the context of yields. In theory yields should decrease if US economy start to collapse again due to lack of stimulus, brought about by investors clearing stocks and pumping them into safer bonds. However, it is unlikely that market demand will be able to make up for the decrease in Fed purchases. On the other hand, if market managed to start running without clutches, the optimism and renewed risk appetite will push yields higher as well. We can simply look at historical price for guidance. From 1962 to 2008, 10Y yields has never fallen below 3.5% despite going through cycles of recession (depression even) and bull runs. The only time yields fell below 3.5% was in the era of QE. Hence if everything revert to normal (e.g. no QE), it is difficult to imagine yields going any other way but up.

Hourly Chart


That being said, volatility in the short run is still possible, which means that bond prices may still push up higher as part of your run of the mill volatility reaction, rather than a directional play. Case in point, hourly chart shows some slight pullback, with prices hitting the soft resistance  around 124.65. Stochastic readings supports the recovery, with readings seeking to form a bullish cycle signal. However, price may find this level hard to break as both fundamentals and short-term pressure remains on the bears side. Even if the 124.65 level is broken, there is a sturdier resistance at 124.8, which happens to be the 38.2% Fib retracement (not shown on chart) of the post FOMC decline (from 125.5 high to 124.35 low). Considering that there has been various peaks around and under Stoch 50.0 levels, it will not be surprising to see Stoch bullish cycle (if even formed to begin with) being cut short and revert pressure back to the downside once again.

Daily Chart


Daily Chart shows a breakout of 125.0 round figure and the bearish rejection of the descending trendline. Currently Stoch readings are also Oversold, suggesting that a corrective move higher is possible as well, in line with what Hourly Chart tells us. Should 125.0 holds in the event of a pullback, the breakout will be confirmed and we should be able to see further bearish acceleration (e.g. higher yields) moving forward, agreeing with fundamentals. Even in the case of prices breaking 125.0 higher, the descending trendline will help to push prices lower, hence increasing the likelihood of a “fakeout” towards the upside.

More Links:
WTI Crude – Pushing Towards 104 on Technical Bears, FOMC Minutes and Implied Demand
AUD/USD – Short Term Bears Remain Despite Chinese Manufacturing Growth
GBP/USD – Pushes to New Two Month High above 1.57

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Mingze Wu

Mingze Wu

Currency Analyst at Market Pulse
Based in Singapore, Mingze Wu focuses on trading strategies and technical and fundamental analysis of major currency pairs. He has extensive trading experience across different asset classes and is well-versed in global market fundamentals. In addition to contributing articles to MarketPulseFX, Mingze centers on forex and macro-economic trends impacting the Asia Pacific region.
Mingze Wu