Raymond James: Where is the next stop for the 10 Year Treasury?

Raymond James Bond Market CommentaryWhere Do We Go From Here?
By Benjamin Streed
August 20, 2012

It was only a few short weeks ago that traders appeared ready to bet the farm that the Federal Open Market Committee (FOMC) would pull out all the stops and initiate yet another round of Quantitative Easing (QE) in hopes of spurring economic growth. My oh my, how things have changed; 10-year Treasury yields have risen from 1.387% on July 24th, an all-time low ahead of the FOMC meeting on August 1st all the way to 1.848% as of Friday’s close. This change marks a staggering 46bp rise in just under one month, the largest such rise in yields since March when the 10-yr yield sat as high as 2.39%. As indicated in the chart below, June’s support level of roughly 1.64% (white box) was easily broken, leaving us with a new and somewhat untested support level of roughly 1.838% seen late last winter from December to February (green box). If this level doesn’t hold it is unclear as to where we will find a new trading range as yields had been in a free-fall since March and have had little opportunity to define any clear set of support/resistance levels. So how does this fit into the economic picture? Remember, Federal Reserve Chairman Ben Bernanke’s statement to the world indicated that any further action beyond the continuing “accommodative rates” would have to be justified by weakening economic data, especially on the unemployment or inflation fronts. Job creation last month was better than expected at +163k on expectations of +100k, while retail sales rose 0.8% marking its largest increase since February. Should indicators such as these continue to show strength they could help fuel continued yield rallies in the Treasury markets as investors attempt to ascertain the next resting point for the Treasury yield rollercoaster of 2012.

The data-dependent Federal Reserve and its expectations are only one side of the coin when it comes to what continues to affect the U.S. Treasury market; European fears/optimism also play a part in shaping the market’s mentality of “risk on” or “risk off”. Although there wasn’t any game-changing news out of Europe last week we did get some interesting sound-bites from German Chancellor Angela Merkel during her trip to Canada. Once again expressing her pro-austerity and very “German” views she commended Canada for having a culture that does not promote “living on borrowed money” and that such a culture should be the model for the 17-nation European Union. As if she needed to drive the point home any further, she remarked that “This is the right solution for Europe” and reiterated policymakers’ unified goals “to overcome the Euro crisis” and of their determination to band together to keep the common European currency. Over the weekend it was expected that European Central Bank (ECB) policymakers would continue to hash-out implementation of austerity and structural reform measures intended for those countries in need of significant monetary aid. As a reminder, Germany’s high court will rule on the legality of Europe’s permanent rescue fund next month. Meanwhile, the two countries in need of the most assistance, Spain and Italy, have yet to formally decide if they’ll request additional help from the ECB to help lower their borrowing costs which remain at unsustainably high levels.

Over the weekend there appears to have been some development in the struggle to contain the Euro-zone debt crisis; policymakers from the European Central Bank (ECB) may be set to outline a plan to finally contain the Eurozone debt crisis. According to Der Spiegel, one of Europe’s largest news publications, the ECB’s governing council may implement yield limits for both Spanish and Italian debt at its next meeting. Each country’s 10-year yield has moved down on the news despite remaining at elevated levels which sit near all-time highs; as indicated by the grey line in the chart above, Spanish 10-year yields are at 6.214%, off from the all-time high of 7.621% seen on July 14th while similar maturity Italian debt yields 5.733%, down from a high of 7.261% set back in late November (white line). Interestingly, the German Central Bank or “Bundesbank” has joined forces with Chancellor Merkel in standing in the way of the ECB’s plan to support limits on Spanish and Italian borrowing costs. The bank is opposed to what it views as “potentially unlimited” government bond purchases by the ECB and, “Holds the opinion that government bond purchases by the Eurosystem are to be seen critically and entail significant stability risks”. Although European politicians appear set for more austerity-related discord, the financial markets will continue to keep eyes and ears open to any further developments and their influence on markets here at home.

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section ofinvestinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.

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