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Reflections #46 - Markets at a crossroad as US10Y testing 2022 high

10 year US treasury yields are testing the 2022 highs at 4.33% which arguably is the last line in the sand before a move higher towards 5%. So what now?

The bulls and the bears will have to fight it out here and despite numerous voices arguing the market is extremely short US treasuries, positioning is far from clear.

According to CFTC data, large speculators are indeed close to record short US10 year futures (see chart 1). However, real money rather seems to be on the other side of the trade with one of the largest bond overweights in the last 20 years according to BofA (chart 2).

Chart 1 and 2: UST Positioning - Large Speculators vs Real Money Asset Allocators

That makes the market very vulnerable to shocks or data surprises. In fact, recent economic data out of the US were not weak enough to support the bond bulls while the recent inflation downside suprises, including the negative inflation prints for CPI and PPI in China, do not really support the bond bears.

When looking at momentum indicators the recent yield move looks stretched but whether this is important when we get a technical break to the topside is questionable. Given the latest momentum, we do see a higher chance we get a break to the topside but remain wary that such a move will ultimately be not sustainable and weigh even more on growth and the US fiscal burden.

Central banks were the dominant UST buyers in the last two decades. However, to expect help from the Fed (QE) or any other central bank looks premature or very unlikely right now. China seems to have stopped buying UST as holdings haven fallen sharply to levels last seen in 2010 (see chart 3). This might even accelerate in case they need to intervene in USDCNY ie sell USD (and UST) and buy CNY. The same may be true for Japan. Lastly, oil producers such as Saudi Arabia also lost its hunger for US treasuries and seem more inclined to buy chips for the upcoming AI revolution than to support the US treasury.

Chart 3: China UST holdings

Make or break

A sustained close above the 4.33% could see US10Y yields accelerate towards the next resistance zone between 4.85-5.40% which were the highs in 2006 and 2007. We would regard this area (if we ever see it) as a great medium-term buy opportunity.

On the other hand, if we fail here and yields turn lower, we would see a retracement towards 3.60/3.80% as likely. A close below 3.30% fully opens the downside back to the rendline.

Chart 4: Make or break in US10Y

Bottom line:

Markets at a crossroad as US10Y yields test the 2022 highs. Issuance pressure and less CB buying seem to support higher yields while positioning is looks ambiguous. We sense the pain trade is still higher but any move above 5% may offer a great medium-term buying opportunity.


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