Let’s Hope A Move In Rates Isn’t Messy

By Bryan Rich 

October 27, 2016, 3:15pm EST

Last week we talked about the set up for a move in global bond yields.  And we discussed the case for why the bond market may have had it very wrong (i.e. rates have been too low, pricing in way too pessimistic a view on the current environment).

Well, today rates have finally started to remind people of how quickly things can change.  The U.S. 10 year yield finally broke above the tough 1.80% level and is now trading 1.85%. German yields have now swung from negative territory just three days ago, to POSITIVE 19 basis points at the highs today.  Importantly, German yields are now ABOVE pre-Brexit levels.

Still, we’re approaching a second Fed rate hike and U.S. yields are almost 1/2 point lower than where they traded just following the Fed’s first hike in December of last year. As for German rates (another key benchmark for world markets), we found with the Fed in its three iterations of QE, that QE made market rates go UP not down, as people began pricing in a better outlook. That’s yet to happen in Germany.  The 10 year yield was closer to 40 basis points when they formally kicked off QE – still above current levels.

But remember this chart we looked at last week.

oct27 germ rates

In the white box, you can see the screaming run-up in yields last year.  The rates markets had a massive position squeeze which sent ten–year German bond yields from 5 basis points (near zero) to 106 basis points in less than two months — a 20x move. U.S. ten–year yields (the purple line in the chart below) moved from 1.72% to 2.49% almost in lock–step.

This time around, as we discussed last week, let’s hope a rise in rates is orderly and not messy.  Another sharp rise in market rates like we had last year would destabilize global markets (including the very important U.S. housing market).

But the buffer this time around should be the Bank of Japan.  Remember, the Bank of Japan, just last month announced they would peg the Japanese 10 year yield at zero.  Even with the divergent monetary policies in Europe and Japan relative to the U.S. (central bank rate paths going in opposite directions), the spread between U.S. rates and European and Japanese rates should stay tame.  That means that Japan’s new policy of keeping their 10 year yield at zero will/should prevent a run away U.S. interest rate market – at least until there is a big upgrade in the expectation in U.S. growth. On that note, we get a U.S. GDP reading tomorrow.

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