The 30-year to be auctioned today will be the last this year

Outlook

The results of the 10-year auction yesterday included a narrowing of the 10/30 year spread to 1.03%, which Bloomberg says is the lowest since Sept 24 and demonstrates demand for the long end. The 30-year to be auctioned today will be the last this year and was yielding 3.88% early this morning, compared to 3.81% at the sale Nov 14. The rise in US yields is the highest among all 18 sovereign bonds tracked by Bloomberg.

That’s more like it. First, it acknowledges that tapering is more likely in Dec or Jan than delay to March, the previous consensus. The pivot shifted with the budget agreement, to be voted on in the House today and then the Senate next week.

A steeper yield curve also means better economic prospects, which will eventually get recognized by the equity gang. The FT opines that it means good news/bad news for emerging markets, since better growth everywhere will inspire new flows into emerging markets and re-ignite the too-strong currency problem, but we are not so sure. If you can get a decent return in US 30-years, why take the extra risk of an emerging market?

The smart Market News FX analyst offers this: Interviews with big FX market players indicates the majority think next year will be the year of the dollar. “The majority of year-end 2014 euro forecasts, coming so far, saw the euro closing below $1.3000 next year.”

We need to worry about a sudden lurch in yields that would panic the stock market (and the Fed), and let’s not forget we had a range of 2% to 4% so far this year—overshooting, indeed.

“Stephen Jen, managing partner at SLJ Macro in London, maintained that while March 2014 ‘is the most probable date of the first tapering ... the second-most probable date is next Wednesday.’” Jen said the Fed claims to be data-dependent, but if that’s true, then next Wednesday it is. "The main reasons for them not to start tapering until March are mostly tactical and psychological. Given the Fed's track record in mis-managing expectations with their forward guidance, I would not be surprised if the Fed surprised markets, again."

We agree with Jen—tapering should begin next week, probably with an announcement of a small amount to be done in January. It’s a cowardly compromise, but meets many of the criteria the Fed is seeking—Bernanke gets the blame instead of Yellen if it goes wrong, a small amount shouldn’t panic markets, etc. Let’s see the response to US data today and other market prices before deciding the dollar “must” benefit. There’s nothing inevitable about the dollar rising even if yields rise, alas. Things could be starting to get tricky.