Calm on 10-year Treasury yield looks skin deep

Summary

A 10-year Treasury yield perched well above 3% leaves investors ‘exposed’ when risk appetite sours.

Deceptive calm

The 10-year U.S. Treasury yield is set to mark a fifth consecutive day of gains above 3%, the longest rising streak for benchmark borrowing costs since the middle of May. After approach to the 3% level triggered volatility earlier in the year, trepidation returned this week, albeit temporarily, to a market already unnerved by the dizzying U.S.-China dispute. Broader reaction has been calmer this time. Investors seem acclimatised, to an extent. But the frisson of anxiety that initially accompanied this week’s dive in Treasury prices shows the rate retains potency. Should risk-appetite wane in the near term, a fall below 3% is again likely to be seen as desirable for a return to stability. We don’t assume markets will remain as sanguine as they appear to be now about the elevation.

High-wire act

On a near horizon, increasing chances of a sustained dollar consolidation could drag. The dollar stumbled this week as a stack of underlying supports wobbled. U. S.-China’s falling out, Brexit—at least until Friday, NAFTA, EMFX all turned less menacing. A run of disappointing economic data also brought speed bumps for the greenback. Speculators had ample pretexts to exit crowded positioning. Upshot: the greenback’s near-10% rally from February lows stuttered in mid-August. At the same time though, long-dated Treasurys’ balancing act— both dollar proxy (via yield) and safe haven (by price)—remains well in play. This sets up faster yield/dollar decoupling when the dollar’s safe-haven appeal is heightened, as of late. But saggy yields can rapidly revive, as per this week, in line with better perceived conditions for riskier markets, by which time Treasury rates might need to move fast to close the gap to dollar pricing. As we’ve seen, such sudden moves can be alarming.

10-year yield won’t fight the Fed

The bigger backdrop is the Fed’s rock-solid rate path. It’s pointing higher well into 2019 before investors see a pause, by which time the target rate could be up 100 basis points from here or more. This should keep any yield (and dollar) fatigue contained. Even if 3% has not been established as the 10-year's ‘resting rate’, we expect plenty more instances when benchmark borrowing costs look unmoored enough to spook investors in ‘riskier' assets.

Thoughts on 10-year Treasury yield technical chart

Technical chart factors are ambivalent about sustainability, but one basic observation is that the yield has truly ‘broken out’. Aside from escape velocity above 3%, the rate is through the top of a five-month range comprising of rising trendline support established in early April and, aside from a 7-session break in May, resistance from 25th April’s close (3.0240%). The upper end of the range has only been breached sustainably this week. That’s after the yield notched a nearby high on Monday (3.0220%).  So, at least some of the melt-up can be characterised as ‘momentum’, though it’s less clear how much impetus remains. It also turns out 3% is not just a totemic round number. The yield notched a highly significant annual close near 3%—3.006% to be exact—in 2013. Annual closes are a simple way for participants to orientate their attitude on an asset for the year ahead and beyond. The case builds for strong support slightly above 3%. On the upside, nothing sticks out that could pose a proper challenge before this year’s mid-May peak of 3.1280%. Despite setting higher daily closes each session since 13th September, the rate’s high this week (on Thursday) was a bit shy of the 3.1280% hurdle, scraping 3.0960%.