Updated: 10-17-2016

Yields and Dollar Jump
Updated: 14-Oct-16  04:20PM ET
Analyst: David Kelland

Long-dated Treasury yields kept moving higher this week with the 30-year yield pushing up 10 basis points to 2.56% and the 10-year yield gaining five basis points to 1.79%. Both of them are now above their 200-day moving averages. There are technical reasons to believe that there is more upside in yields ahead. Initial resistance in the 30-year yield is at ~2.62%, the August 2015 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 charts below)

The other trend that has been gathering momentum in October is that the U.S. Dollar Index is up 2.8%. The weakest major currency against that dollar rally has been the British pound, which has suffered badly from market resignation to a U.K. future without access to the single market. Since roughly 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 cheaper U.K. imports until the U.K. actually loses access to the single market.

A stronger U.S. dollar pressures the Chinese authorities to intervene more forcefully in USD/CNY or to devalue. The pair is currently trading at a six-year high and the steady drip of headlines about structural problems in the Chinese economy is accelerating. The timing of further devaluation is almost impossible to predict, but it looks like an inevitability given the debt problems in the middle kingdom.

The higher-than-expected PPI growth announced on Friday shows that inflationary pressures are slowly building in the U.S. Even if the return of inflation has been sluggish, it is much more sustained than anything seen in Japan or the eurozone. That leads investors to believe that the Fed will have room to hike rates at the December FOMC meeting and strengthens the greenback.

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

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

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

- David Kelland, Briefing.com

  • 10-Year Yield (Daily):

  • 30-Year Yield (Daily):
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