Get ready for one of those days where people say a lot about not wanting to be “long going into the weekend.” Except perhaps in bond markets, where the rush to government debt intensified with President Obama’s remarks that the US is ready to provide air support through airstrikes against ISIS, which now controls a big swath of Syria and Northern Iraq. That’s forced a big move into U.S. and German yields, among other things, which is undermining some of the recent strength in the dollar as well. (That’s not to say it’s a strong-euro move, more of a weak-dollar move, given the declines in the dollar against the yen as well.)
What’s striking here about the rallies in U.S. debt and German debt is that even though there’s a substantial safe-haven bid behind both markets, the difference is the German 2/10 spread has narrowed from about 1.73 percentage points to 1.04 percentage points since the beginning of the year thanks to a big move in the 10-year, a bull “flattening” trade that reflects ongoing concerns about economic growth in Germany, and more broadly, in Europe.
The United States has also seen a flattening as well, and also about 60 basis points, from 2.59 percentage points to 1.97 percentage points. There’s a slight rise in the two-year note embedded in this move, though, and while the 60-basis-point move in the US 2/10 isn’t as big as the 70-bp move in Germany, it’s still significant.
The difference is that the difference of two percentage points is still closer to the historic norm that suggests a stronger economic outlook. Short-dated rates are of course being held back by the Fed and ECB, but that’s becoming less so on the U.S. side of the equation. Either way, the move below 2.40 percent and the big increase in central bank custody holdings ($28 billion this week) supports the idea that there are growing worries, mostly of a global political nature, that are affecting markets right now that’s likely to persist in a vacuum where earnings season is winding down and economic figures have been relatively consistent.
So where might the market go next? Analysts at CRT Capital see the likely strongest performance in the 5-7 year area, in part because next week’s supply of 3s, 10s and 30-year bonds will likely imply a concession in those maturities that will keep a bit of a lid on the strength there.
However, CRT suggests that the 10-year yield would find support at about 2.55 percent (if it ever gets that high again) and likely resistance around 2.35 percent. Watch for the weekly CFTC data late in the day as well – short positions in the 10-year have been steadily worked off (or beaten out of those stubborn enough to keep those positions on) to a point where net shorts were nearly even last week at short 5,800 contracts, smallest since a long position in July 2013. If all of that is worked out that short-covering may finally have run its course.
The stock market is an odder duck right now. Futures are higher, having rebounded from big post-Iraq-worry losses during the night, but it’s hard to imagine any kind of buying power taking the market all that much higher on a Friday and uncertain situations in Ukraine, Israel/Gaza and Iraq/Syria. The total revenue of U.S. companies to most of those areas is very, very small, but at times like this that’s not the calculus investors are using.