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Wednesday, 3 July 2013

Will Jun payrolls be the straw that breaks the bull market's back ?

We're on the verge of breaking a rather serious trend. This is the 10yr yield since 1980 (the secular bull market in fixed income, older than half the people currently trading it). If 2.50 goes, then watch out. Will Jun payrolls be the straw that breaks the bull market's back  ? 

After good-to-strong recent data (ADP, car sales, durable goods), and a 25bp rally in 10s to flush out the uncommitted shorts, the pieces could be in place for a move to new yield highs. The obvious near-term target is 3%, about the same 150bp selloff that we had in Jun 2003 when the market realised that the last cut had arrived and the next move in rates would be higher. 10y notes have sold off 50bp due to the FOMC (2.16 to 2.66), and retraced 25 to 2.41. A second 50bp selloff from 2.41 would get to 2.91. Presumably that needs a strong payrolls number, which might be what the strength in consumer confidence and spending is saying. *If* we get to 3% then the above chart suggests we're in very scary territory. 

Here's a slightly biased perspective on current data :

5 yr highs                                                                               5 yr lows

Consumer confidence
Michigan, Bloomberg, Gallup, Conference Board

Housing market
NAHB index, permits, new home sales, Case-Shiller,
     S&P Comp-20 YoY change, existing home sales

Labour market
JOLTS job openings 3mma                                                   Jobless claims 4wma, unemployment rate
Gallup job creation index

Vehicle sales, NFIB optimism

and just for the record :
Fed balance sheet                                                                   Fed Funds rate 

What weakness there is comes from China, the Gulf, perhaps the Eurozone, and lagged effects of the sequester. I'm only really concerned about the first two.

The point is that broad swathes of the US economy, covering housing, consumer confidence & spending intentions, the labour market and business confidence, are recovering strongly, while monetary stimulus remains at full throttle. The Fed have stepped away from the controls and are claiming they won't come back before 2015. Fixed income had a wake up call last month, but 10s at 2.50 aren't cheap : how many investors who were bullish or confidently sitting on carry trades two weeks ago have had time to adjust to a bearish mindset ? Usually the shock of a loss takes longer than a fortnight to heal, so I think the path of least resistance is towards higher yields as people re-position themselves for a tightening Fed.
The "brave" trade here is to maintain a short into payrolls : buy short dated put spreads on TY and US and buy back the lower strikes of any longer dated put spreads in the hope of re-establishing them at much better levels. Actually it's not really that brave - the risk/reward based on the chart above makes the short trade the easy one. The scary trade here is to be long.

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