Bond Yields Will it work this time

Reports of rising bond yields are ubiquitous these days.

The argument that US GDP will grow faster in 2013 rests on expectations that the US will avoid the $600 bn fiscal cliff courtesy of an eventual resolution regarding a higher debt ceiling and that the agreed upon cancellation of the Bush-era tax cuts on wealth individuals will not hit the economy.

Another argument favouring yields is that further gains in US and global equity indices will trigger a positive transmission mechanism into the economy from corporate spending and household wealth.

There are also inflationary concerns as: the Fed maintains asset purchases until unemployment nears 6.5% (from the current 7.8%); Japanese PM Abe issues a supplementary budget of yen 12-13 trillion—higher than the anticipated yen 10 trillion and requests the Bank of Japan introduces unlimited bond purchases to double its CPI target to 2.0%; and the Eurozone economy benefits from falling periphery bond yields to the extent of further boosting equities alongside bund yields.

The combination of “positive growth” factors and inflationary concerns cropping up in H2 is likely to bring about the transition of supportive yields towards a full fledged rally.

The technical picture for yields looks increasingly bullish. The three-year trendline is in the process of being broken, which will likely give way to the 100-week moving average—near 2.19%. Moving into the monthly chart, a more important target is noted at 2.40%, which is the previous support (Oct 2010) becoming resistance (Oct 2011 and Mar 2012). Once these levels materialise, the road opens towards the six-year trendline resistance near 2.60%. This would imply a 100% increase from the July lows of 1.37%. Support rests at the six-month trendline of 1.64%.

For currency traders, these developments are especially negative for the yen due to Japanese investors’ appetite for yield. We expect the next phase of aggressive yen weakness (and new phase of yield gains) to take part later in April when the BoJ governor Shirokawa’s term expires, allowing PM Abe to appoint his own man to conduct a more “inflationary” policy. USD/JPY at 97 and EUR/JPY at 123.00 are realistic targets for early Q2.

For a look at our previous Yen-Yields calls, please view here, here, and here.