As the latest scene in Europe’s sovereign debt drama continues to unfold, the fear trade that drove investors into the safety of U.S. Treasurys is unwinding, leaving investors to question whether interest rates may have seen what could be among the lowest of the year.
Kevin Ferry of Cronus Futures Management takes it a step further and predicts that Treasury prices have topped out and yields, which move inversely, hit bottom for 2012 and possibly beyond, when the 10-year touched 1.834 percent last week. Today, the 10-year yield was at 2.064 percent in late trading.
Ferry said since the 10-year slid below 1.7 percent last fall, he has been watching rates and now believes they are carving out a low, or bond market top that is the mirror opposite of the market bottom formed in the early 1980s, when interest rates were spiking.
“The move we’ve seen in the last couple of days is cyclical, but we’re talking about a secular move,” he said. "They (Treasury bonds) were universally hated (in the early 1980s.) Now they are universally embraced," he said, adding the trade is overly crowded.
“We may have seen the high of our lifetime," he said of Treasury bond prices. Ferry said it seems that the fear trade that drove investors into U.S. Treasurys as European sovereign rates climbed, is abating. Many investors were looking for one more run-up as Greece negotiated with its creditors but that has not come so far, he said.
David Ader of CRT Capital is in the opposite camp. “I think we started backing up in yields because we discounted some friendly information. Right now, we have a nice concession from the Fed and a nice concession from supply, but I think we could get weaker,” he said.
“We came into the year with a range bias of 1.50 to 1.75 (percent yield) on the 10-year note on the downside, and 2.50 to 2.75 on the upside, with the bulk of the range well within that context, and I think that’s what we’re doing,” said Ader.
Ader said the threats from Europe's sovereign problems and political threats from there and Washington are potential issues for the market. “I think it’s going to be a chop-a-thon. We could very readily visit those low yields sometime in the next few months, “ he said.
George Goncalves, Treasury strategist for Nomura Americas, said there may be another dip lower on European news, but yields were probably close last week to what will be the year’s lows. The 10-year yield of “1.83 would be a pretty formidable low to breach. Something terrible would have to happen in Europe. You’d need a catalyst—not just a grind lower in rates,” he said.
“Even if the Fed is dovish, we could still see rates back up because it’s really a normalization of the European fear coming out of the bond market, “he said.
John Briggs, senior Treasury strategist at RBS, said he turned bearish on bonds last week, but he’s not ready to call a top in prices or bottom in yields yet. “It’s possible, but considering it’s January 23, with the myriad of risks that still present themselves, I’m reluctant to call it the low,” he said.
“We’re still negative but debating how to handle the Fed this week, which is going to be a short term positive. It depends how their forecast comes out. Right now, the first quarter of 2014 is where the first rate hike is priced in but if the picture says it’s not going to happen until 2015, then there's going to be a mechanical flattening of the curve…that will pressure yields down. Or, they just might verify what’s priced in now,” he said.
The Fed begins its two-day meeting Tuesday and releases its statement and forecast Wednesday, including for the first time individual forecasts on Fed funds rate targets from its members.
Europe remains an unknown for markets, even as markets appear to be calmer and moving away from trading on every headline. The Greek government will now submit a final debt swap offer to private sector bondholders by Feb. 13. The euro rose above 1.30 Monday for the first time since Jan. 4.
"We're seeing these headlines that Greece will come up with a plan by Feb. 13. What happened to Friday?," said Ader.
There were hopes there would have been an agreement on the size of the haircut private sector investors would take by this past weekend. Late Monday, Reuters reported that European finance ministers rejected the offer from private sector bondholders.
Briggs points out that the Portuguese spreads have remained wide even as those of Spain and Italy have narrowed, raising the specter of hair cuts for Portuguese debt.
Ferry said he doesn't really mind if his call is proven wrong by another drop lower in rates. "People say what if it makes a new low. I'll say, good. I'm more convinced I'm right," he said. "Now they're all packed in at the lows, and everybody's telling you, you have to have them."
Unlike other recent periods when U.S. rates were at lows, emerging markets central banks have now been lowering rates.
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