A booming US economy and comments from Fed chairman Jay Powell last night appear to have been the catalyst for a sharp move higher in US 10 year yields through the highs this year of 3.12% to push up to within touching distance of 3.25% and the highest levels since 2011.
The latest non-manufacturing ISM report for September saw economic activity to kick on to its best reading since 1997. These was little sign in any of the internals of any significant weaknesses below the surface either. Prices paid was slightly higher, while the employment component also jumped sharply to 62.4 from 56.7, pointing to an acceleration in economic activity.
Powell’s comments that he was very happy with the US economy, and that he could see the current expansion continue for some time, appears to raise the prospect that not only could we see another rate rise in December, but we could well see at least three more in 2019.
In particular his remarks that we’re a “long way” from neutral have raised the prospect that rates could go quite a bit higher in the next few months, particularly since he went on to state that interest rates were “still accommodative” even if they aren’t “extremely accommodative”.
This would appear to suggest that rates could go up by more than the 1% that is currently starting to be priced by the markets by the end of 2019.
At the beginning of this year, the prospect that we might see at least 7 rate rises by the end of next year, was seen as fanciful, however the fiscal stimulus at the beginning of this year by the Trump administration appears to have changed the game in this regard.
The break above 2.65% on the US 10 year at the beginning of this year was an early warning that the long term downtrend for yields in the US bond market was coming to an end.
The price action since then, as shown here, has also lent itself to that interpretation, as we haven’t come close to moving back below the 2.65% level since that break higher, and now we appear to have broken out of a potential double bottom reversal that has been playing out over the last 8 years.
This potential double bottom reversal equates to a 175 basis point move from the bottom off the channel to the top of the channel. Given that this pattern has played out over the last 8 years any prospective move higher could take equally as long to play out, but it still suggests that rate markets are not only starting to turn around, but now set to accelerate higher at the longer end. The movement in the 30 year yield isn’t as conclusive on a reversal but even here we’ve broken the longer term downtrend, from the 1985 peaks.
The break above the peaks this year and in 2014, have also brought the 200 month moving average into play for the first time since 1989.
A monthly close beyond this level, currently at 3.21% could well precipitate a further rise in yields towards 3.5% in the coming months, and in the longer term prompt a slow move higher towards 4% and then 4.75% over the next 5-10 years.
While it’s easy to be sceptical of analysis when set against fundamentals, the momentum for rates has changed quite a lot in the past two years and the direction of travel is now pointing to the prospect of much higher rates several years out.
The next few months are likely to be critical in how the next phase for rates is likely to play out, but investors need to be aware that the next move could well be much higher rates from where we are now.
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