Wednesday, January 22, 2014

Treasuries and Bunds Diverge

The 10 year German Bund bonds have been much stronger than the 10 year Treasury bonds over the past 3 months.  The outperformance of the Bunds is unusual.  They usually trade together at a high correlation.  Even with tapering supposedly priced in, the divergence continues.

The market is sensing that the ECB is about to pull its final card, which is QE.  The most deflationary part of the world is in Europe.  And with interest rates at 0.25%, the only option is to QE, although supposedly it is against their charter.  If Draghi wants to QE, he will find a way around the rules and do it, like LTRO.  

With the relative weakness of Treasuries to European sovereigns, and Jon Hilsengrath squawking that Fed likely will continue taper despite the weak nonfarm number, there should be one last push higher in yields, sometime in February or March.  I expect another run towards 3-3.10% in the 10 year Treasuries.  That should coincide with a top in the US stock market and would be a good time to get long Treasuries, short ES, or short the USDJPY.

10 Year Treasuries


10 Year Bunds



2 comments:

Anonymous said...

Given the recent economic data, I agree with your earlier view that the biggest risk is slowing economy recovery. It seems that market is getting warmed up with this risk. Therefore the best trade is to long 10-year Treasury. Yield will decline regardless of the decision on QE because:

- If QE3 is further reduced despite tepid economy recovery, then concern over economy slow down will lead to flight to safety.
- If QE3 is maintained, then 10-year yield will continue to be suppressed by QE.
- If QE3 is re-raised, then 10-year yield will be further suppressed by QE.

Is it correct?

Market Owl said...

Well, the 10 year Treasury has rallied for the last 3 weeks, so its not a slam dunk trade. I do believe the 10 year yields will get back down to 2% sometime this year, but it will be choppy for the next couple of months.

I also don't believe the stock market has topped out yet, so I can't be too bullish on bonds just yet. And recently, bonds have not been able to go higher for long without stock market weakness.