Originally published by AxiTrader
Key Takeaway
As someone who was managing interest rate portfolios at State Super back during the bond market rout that was 1994 I'm acutely aware of what can happen when traders and investors get caught on the hop.
It's not pretty.
And even though markets are now fully expecting a rate hike in the US this month, and then two more this year according to the latest Reuters poll, it strikes me that bond investors are still woefully unprepared for the real impact of the Fed's tightening cycle and what is increasingly a global reflation cycle.
That's especially important given that the US 10 year Treasury is on the cusp of a close above 2.6% for the first time since September 2014.
What You Need To Know
I love foreign exchange markets. But I started off in interest rates back in 1988 and during the bond market selloff in 1994 I was managing a short-term interest rate portfolio of more than $1 billion.
In the overall 30 year rally in bonds if you look at a long-term chart of rates now you can hardly notice that selloff of 1994 unless you are looking.
Like many of my peers (I was only 25) it was my first experience of a significant selloff. And like many of my peers I completely underestimated how far, fast, and hard it could run.
Luckily I had two great mentors as my bosses - Greg as my direct senior PM, and Peter as the head of the fixed income section. Both kept me out of trouble and disabused me of any notion of trying to buy the selloff too early.
The reason I raise this is that with the US 10 year bond only a strong non-farm payrolls away from closing above 2.6% for the first time since September 2014, I wonder if we are on the cusp of a savage move higher in bond rates in the US and across the globe.
That's particularly the case because many traders now, like myself and my peers in the early nineties, have been trained to expect sell offs to be fairly muted.
But back in the 1990's we had something that traders don't have anymore. We had the buffer of a very solid yield and coupon combination to insulate us against the capital losses of rising bond rates.
Now though with rates and coupons so low, and with fixed income an asset class that many investors are likely "over-invested" in since the GFC, a bond market rout, if it occurs, could get ugly, causing significant capital losses.
The bond bulls will say, like the OECD this week and Bill Gross last night, that the global economy still faces many risks. That is true.
But what is equally true and undeniable is that there is certainly a global reflation going on right now. That's something the ECB tacitly admitted just last night with it's changed language around monetary accommodation and Mario Draghi's comment that the "urgency" to act was not as acute.
Which brings me back to US 10-year bonds.
A close above 2.6% on a weekly basis, the fist such close in two and a half years could open up further selling and target the long term downtrend resistance from 1987 which comes in at 3%.
As the chart shows US 10's have run a long way fast since the lows before the election of president Trump. So in some ways the 1994 analogue has already started.
But if non-farms is strong and 2.6% breaks on a weekly close basis, the bears could go wild with rates this low there is simply nowhere to hide. And then 3% has to hold.
What a bond market selloff will do to stocks and currencies is harder to tell. My sense is up to a point, perhaps 3% on US 10's, the focus will remain on the economic growth story supporting the Fed moves and bond rate rises.
But above that, I fear a whole other kettle of fish.
Have a great day's trading.