Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
Where are Treasury yields heading? A technical analysis.
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Ten-year US Treasuries yields may rise fast towards 1.5% once they break above their upper trendline at 1.22%. When we compare 10-year Treasury yields to the 10-year Breakeven rate, we find that there is a mismatch between the two. Either inflation expectations are too high, or 10-year yields lag the breakeven by 100 basis points, giving more context to a substantial selloff. On the other hand, 30-year Treasury yields are not as far away from inflation expectations, but there is potential for them to rise to 2.4% in yield.
Last week 10- and 30-year yields hit a new high since February 2020. The fear for inflation to surprise on the upside is a concern that started to push US Treasury yields higher since Biden won the November election. However, which yield levels should we watch out for?
Starting from the 10-year yields, we see that they have been trading in a downtrend channel for decades. Interestingly, a horizontal line around 1.5% has served as support since 2012. That horizontal line was broken in February last year amid the Covid-19 pandemic. Now it serves as a resistance level if yields break and sustain trading above 1.22%.
As we take a closer look, we see that although 10-year yields closed last week at 1.2%, they failed to break above their horizontal resistance line at 1.22%. We are now facing two scenarios: either yields break and sustain trading above 1.22%, or they will fall to try the lower trendline of the channel they have been trading since August 2020. Suppose 10-year yields break above the 1.22% resistance line. In that case, yields might rise fast towards 1.5%. Yet, as highlighted above, the 1.5% level is a strong resistance level, giving the market some respite after the selloff in Treasuries. A strong auction of TIPS this Thursday and retail sales numbers can be catalysts for such selloff. Additionally, if yields sustain trading above 1.22% a catch-up effect can trigger bond future stops causing a fast rise to 1.5% in yield.
When comparing 10-year yields to the 10-year Breakeven rate, it looks that the selloff in Treasuries can be even more significant than what we discussed above. Indeed, the difference between the 10-year Breakeven rate and 10-year Treasury yields is around 100 basis points -the highest in twenty years. It means that either inflation expectations are too high, or 10-year Treasury yields are too low and will need to rise by 100bp to catch up with it.
Although 30-year yields are also trading below the 30-year breakeven rate, it is essential to note that the spread between the two of them is only of 15bps. It means that 10-year Treasuries are significantly more overpriced compared to their 30-year peers.
As per the image below, thirty-year Treasuries have also hit a milestone last week, hitting 2% in yield for the first time in a year. If they sustain above this level and break above the channel, they have been trading in since August they will find support next around 2.4%. Otherwise, they would fall to test resistance on their lower horizontal line at 1.75%.
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