June 2. US bonds still attractive to foreign buyers
–Green euro$ pack fell 4.5 bps on Friday and was the weakest part of the curve, while the ten year note yield rose just 1 bp to 2.455. Implied vol firmed in front of this week’s events: the expected easing of the ECB and the US employment report.
–On a long term yield graph, US tens have been in a downward sloping trend since 1986. Actually rates have been falling since 1981, but the clearly defined trend channel starts in ’85-86. Upside breakout level is around 3.10%. Given the surprising fixed income rally this year, the press is giving a megaphone to those trying to call a top. For example Reuters: “US bond mkt faces possible reckoning.” FT: “US inflation rise adds to Fed confidence… A pick-up in prices could mean an earlier jump in interest rates.” GS has consensus client call for end of year bond yield of 3-3.25, along with 3% GDP growth. BAML also looking for yields to base. http://www.zerohedge.com/news/2014-05-31/groupthink-101-what-all-goldman-clients-believe-will-happen
–However, from the perspective of non-US investors, dollar based assets probably still look attractive. The EU vote is anti EUR and the ECB is facing deflation. Japan’s only choice appears to be massive devaluation. China appears to be slowing and struggling with its own housing issues. The point is, at the margin, both US stocks and bonds have relative appeal. Strength in the dollar index may be the big trade for the rest of the year. The inflation indexed ten year (TIP) yield has gone from around 3/4% to just 20 bps this year. Why is that trend supposed to stop? And why has it been so aggressive thus far? My guess is that ECB stress test info has already dribbled out and isn’t particularly robust. China’s financial system is facing a hard landing, Brazil is likely to face a World Cup hangover. To think that US growth will snap back to 3% if the rest of the world is faltering is wishful thinking. From Paul McCulley (cited on Prudent Bear), “And ultimately we had to get to this point where the marketplace broadly defined – all asset classes are accepting that risk-free cash trades at par – you get it back tomorrow – should not provide a real rate of return. It’s preservation of capital – period. If you want to have a real rate of return you have to be in assets.”
