The start of the second half of the year was met with a sharp move lower in US 10 year bonds. Why?

The answer is far from obvious. Is the market returning to buying US 10 year on US labour concerns? Is it worries over the spread of the COVID-19 virus? Lack of confidence in the Fed in that they are exiting their policy too early? Or is it simply a rotation out of stocks into bonds with stocks having had a great first half of the year.

All of these make sense in isolation, but the conviction to highlight any is low. It looks like clutching at straws.

Big picture remains the same

In short, nothing is really going on in the bond market that changes the big picture. The big picture is that the US is moving towards normalisation and, with all things being equal, it is going to get there.

A recent Reuters poll in June showed that bond trades expect US 10’s at 2.0% (currently under 1.50%).

The further US 10 year yields fall right now, that makes for a good opportunity to short the bond market. If we could get back down to 1.00% then that should have flushed out all buyers for now.

Most likely it seems that the recent drop back in growth and inflation is most likely the reason for a pullback in yields as the curve flattens. However, this is a pullback – not a fundamental shift, so just use technicals to define risk. This is not full in panic mode yet. The core view of higher yields makes sense by year-end.

The seasonals

The USDJPY seasonals show that the USDJPY tends to be pretty weak around this time. Over the last 15 years, the USDJPY pair has fallen 11 times. The average fall has been -1.26% and the largest fall was -5.41% In 2007. This large fall makes sense with all the JPY strength on risk-off flows. So, going forward the seasonal pattern tells us that this is a pretty strong period for weakness and it may make more sense to look at buying USDJPY into the end of the year from around September.

The takeaway

The key level to look at for US 10 year bond yields is the level marked on the chart below.

If US 10 year yields start to move above the trend line marked then look for buyers to come back into the USDJPY.