Follow Through...Will Yields Hold?

A: The past week was a very exciting one for traders. With lots of volatility comes good profits; as long as you are on the right side of the trade. When I was an equities trader I used to hate the slow, non volatile markets that made it hard to predict short term movements. Last week, markets reacted to what could be a new world of higher rates and the movements were volatile. Which leads us to this coming week and the economic reports that are set to be released. Be sure to watch if higher yields hold onto last weeks moves, correct back down a bit, or make another strong surge higher. The world may not be done changing yet!

Over the last week, yields on the 2YR, 5YR, 10YR & 30YR all surged to near peak levels seen last June; when analyzed over the past year. To show you just how dramatic the moves have been, take a look at the last 4 weeks (in the below chart) in the US Treasury bond markets that should explain to those who don't understand, exactly why their debt payments are getting 'more expensive'! (doesn't include Friday's big moves for some reason, so please take into account that yields are higher than noted here)

Leverage was used waayyy to much in the 'old' low interest rate world; you know, that world we are just leaving! But there is still tons of liquidity out there and plenty who are not heeding the wake-up call. Fact is, rates are only higher than where they have been and could very well be headed to much higher levels.

According to Yahoo Finance and via FT.com:

Investors have got used to taking ever more risky bets, assuming a stable economic backdrop, low inflation and low interest rates. They have been right for a long time. In recent years maximum leverage has been the right call....

...The recent sharp rally in global government bond yields is a wake-up call that things might have gone too far. The massive 30 basis point move in 10-year Treasury yields in the space of as many hours last week was the most dramatic.

And the recent sharp adjustment shows that even predictable US Treasuries can still spring surprises. The real risk is that long-rates will continue to move higher as still flattish yield-curves start to steepen to more normal levels. Or, more alarming, that a real inflation scare will give rise to greater market volatility.

It's NOT just in the US either! Globally, investors and consumers are waking up to a world where debt is more expensive! Check out this chart on the right, showing the movement in 10YR gov't bond yields (actual basis points where 1 basis point = 0.01% move in yield) in some foreign markets.

In this new world, you could start to notice some re-allocation of assets, especially amongst large institutions and private equity groups. For stocks, in a rising rate world consumer staples and healthcare get more attractive while utilities and REIT's get less attractive. What you need to look out for is whether it will happen or not. So, carefully watch what happens to these boring bond yields this week and their reactions to the inflation data expected to be released. On tap for this week includes:

BEIGE BOOK - Wednesday
RETAIL SALES - Wednesday

PPI - Thursday (expected to rise by 0.5%)
CORE PPI - Thursday (expected to rise 0.2%)

CPI - Friday (expected to rise 0.6%)
CORE CPI - Friday (expected to rise 0.2%)

Given the volatility, and that a sharp move was already made it makes it very difficult to predict what will happen next. While rates are STILL at low levels and there is plenty of upside potential, I think traders will wait out the economic data before making bigger bets. But definitely keep an eye on whether or not yields will hold at these levels, correct back down a bit, or start a new run towards higher levels.

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