Last week I suggested the Fed would likely remain on hold for the remainder of 2015. On Friday at a speech in Cleveland, Yellen said that a rate increase would be appropriate later this year. (Who are you going to believe, a TraderPlanet contributor, or the Chair of the Federal Reserve?) On Wednesday she presents her semi-annual testimony in front of Congress. I appreciate the idea that the Fed wants to begin normalizing rates, but I think that both domestic and international factors will continue to still the Fed’s hand.
But this post isn’t really about the Fed Funds rate, it’s about the longer end of the US treasury curve. The US ten year note yield reached a high this calendar year of 248.5 on June 10. There were two subsequent tests of this level. On June 26 we reached 247.4 and on July 13, 245.5. At the settlement of futures Tuesday, the ten year yield was 240. I now think there is about a 70% chance that the ten year yield has put in its high for the year. (The range on the year has been 164, the low from late January, to last month’s high, 248.5). So we’re much closer to the recent peak than the nadir.
What are the reasons that yields may stall? Are there catalysts for long rates to take another dip lower? Here are the factors that I would suggest: First, Greece. While the Greek ‘deal’ appears to have kept Greece in the euro, and thus maintained the status quo, there are reasons to believe that the damage incurred by the Greek financial system will continue to be a drag. Further, acrimonious negotiations, and their implications for other peripheral countries, will likely keep the onus on the ECB to alleviate fiscal headwinds, and that means taking action to weaken the euro.
A weak euro/$ is, at the margin, likely to be somewhat disinflationary for the US, and also negatively impact US exports. [EURUSD was 110.03 late Tuesday]. Second, if there is a deal with Iran, it is likely to be somewhat negative for the price of oil. The initial response to the Iranian deal was an immediate drop in August Crude, though it had recovered by the end of the day, closing positive. In any case, in spite of what is a supposed recovery in the global economy, oil is nearer the low of the year’s range rather than the high. Again, disinflationary. Third, (and this is in part related to energy) the Canadian dollar and Aussie dollar are showing signs of weakness.
Back month Canadian Bankers Acceptance futures (3 month interest rates, similar to Eurodollar futures) are making new highs, a sign of weakness in the economy to our north. Fourth, China, which has become a bigger part of the global economy, appears to still be struggling. I don’t have any special insight into how to judge Chinese data, but both iron ore (-22% ytd) and the Shanghai Steel Rebar contract (-19%) have been extremely weak this year, notwithstanding the gov’t engineered ‘recovery bounce’ in the Shanghai Composite. Fifth, domestic (US) data has been mixed, with weak Retail Sales yesterday -0.3 vs +0.3 expected, and zero wage growth in the last employment report. Sixth, there has been a decent amount of corporate borrowing recently, in an effort to lock in now, before rates increase. I think that corporate bond issuance is likely to ease somewhat going into year end.
My opinion is that the US ten year rate will spend the rest of the year between 220 and 250. Obviously, there can always be a surprise that jolts rates out of range, but I would suspect that unexpected events are more likely to favor a push to 200-210 rather than 260-270. What if the Fed DOES hike in September? Although a rate hike typically would raise rates across the curve, depending on the market’s assessment of the domestic economy, ten year rates may not move up. In order to express this view I would look at buying TYV 126.5/127.5 call spreads. October options are based on TYZ5 underlying contract which settled 125-055. They expire on September 25, after the September FOMC meeting. The call spread settled at 16/64’s. Maximum loss is premium paid of 16/64’s and maximum gain is 64/64’s if futures are at or above 127-16 at expiration.
Alex Manzara
