Divergent monetary policies

At its December 2016 FOMC meeting, the US Federal Reserve raised interest rates by 0.25%, bringing the range of the federal funds rate up to 0.50% to 0.75%.  The US economy (IWM) (SPY) has clearly begun its tighten its monetary policy with more rate hikes coming during the course of the year. This has led the 10-year US Treasury yields to soar. From a 1.8% in November 2016, the 10-year US Treasury bond (TLT) (IEF) now yields around 2.4%.

On the other hand, yields on the Japanese 10-year government bonds of JGBs stand pinned at near 0%, while the doves continue to fly over Europe (VGK). With inflation and growth still low, we’ve seen the ECB president Mario Draghi extending the quantitative easing program in place.

- Advertisement -

Global arbitrage may cap the 10-year treasury yield at 2.4% to 2.6%, says Bill Gross

Hence, for the US, “global arbitrage effectively caps the 10-year at 2.4% to 2.6% levels,” noted Bill Gross in his January 2017 Investment Outlook. For the first year that Donald Trump is in office, Gross does see the 10-year Treasury move higher driven by an unclear fundamental perspective. In the later years, however, the influence of technical indicators would become stronger as a strong 3-decade long downward trendline sported by the 10-year Treasury would increasingly be at the risk of being broken.

For 2017, Gross finds the 2.6% yield level as critical for the 10-year Treasury, a breach of which could result in a “secular bear bond market.”

- Advertisement -