By Ric Spooner, Chief Markets Analyst, CMC Markets Australia Bond yields continued their move higher this week. The move lower in the second half of May has now been revealed as a brief downward correction against an ongoing rise in yields. On Monday, US 30 year bond yields moved past the early May high of 3.12%, closing last night at 3.21%. The Australian 10 year yield also began to inch past the recent high of 3.05% in yesterday’s trading. Australian bank shares famously benefitted from the yield chase caused by very low bond yields but this party looks like it’s over. Although, the Fed has not yet begun to lift rates, bond markets are not waiting around for it to dot the i’s and cross the t’s. With the writing of higher rates on the wall and fears of deflation receding, bonds are being sold and their yields rising well in advance of any move by the Fed. The current sell-off in Australian bank shares has been mainly about markets positioning for this “normalisation” of bond yields. The key questions for bank shareholders are now going to be just what “normal” turns out to be for bond yields and what that could mean for the market valuations of bank stocks. The question and answer session of RBA Governor Glen Stevens’ speech yesterday included an interesting discussion on the first question. Mr. Stevens noted that rates are likely to be considerably lower than the pre GFC average for some time to come. Former US Treasury Secretary and widely respected economist, Larry Summers recently suggested, for example, that the coming Fed tightening cycle would see its rate peak at around 2.5% with the next easing and QE cycle starting from around that level. So it seems possible that the new normal for bonds could be something well below the pre GFC historical averages for some time to come. Timing is as usual another major consideration. While there is a general global adjustment underway in bond markets at the moment, there may be ultimately differences in the timing of central bank moves to adjust cash rates. This morning’s cut in New Zealand’s cash rate is a reminder that in this neck of the woods, central banks still have an easing bias while the Fed is looking forward to tightening. US 30 year bond yield chart Source: CMC Markets So what light can the charts shed on these issues? The chart aboveincludes a couple of pattern based projections which could generate potential objectives for the long US bond yield. US 30 Year Bond yield On the immediate horizon is a possible ABCD pattern consisting of the swings labelled in capital letters. This cuts in close to the 61.8% Fibonacci retracement level around 3.3%. Here the CD swing would be 127% of the length of the AB swing. 127% is a commonly used Fibonacci ratio. A second alternative is up around 3.5%. Here CD would be 161.8% of AB. At this level the more recent swings labelled in red would also be equivalent i.e. ab=cd. Certainly a 3.5% long bond yield would seem consistent with a scenario where the Fed rate was making a very gradual ascent towards 2.5% with the long term inflation rate around 2%. I’ve shown this yield chart to make it a bit easier to compare prices. However, bonds are traded in prices and that’s the way they appear on our Next Gen platform. Rising yields mean falling prices in bond markets. CMC Markets is an execution only service provider. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
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