Over the last few weeks, bond market watchers have been obsessed with the grinding higher of the rate for the 10 year Treasuries. Slowly but surely it has been making its way steadily closer to the three percent mark that many analysts fear will signal still more pain in stock markets.
This could be a legitimate concern. What they should really be watching for though is the rise in the 30 year Treasuries. The two government securities have one thing in common. Both have marched a good 50 basis points higher this year so far.
Yet the 30 year dated Treasuries are dangerously close to highs they managed to touch in all three of the past years from 2015 to 2017. This is the 3.24 percent level. It is critically important because it represents a line in the sand. Over it will see a rout in the bond market sell off that has so far been reasonably orderly. This chart shows how close we are to such a destabilizing event taking place:
Breaking though 3.24 percent quickly opens the way to 3.5 percent and even 4 percent bond rates. It matters hugely since a true bond market crash can (and has) rippled over to significantly impact stocks. If severe enough, it could herald the arrival of the next credit crunch.
How close are we to this happening? Several events hold the keys to such a bond Armageddon. One of these surrounds the continuing supply of Treasuries. The Trump administration needs to raise more money as the tax cut is at least initially reducing revenues this year. Besides this, Congress passed an aggressive spending bill with an additional $300 billion in new budget outlays.
This past week alone, investors had to soak up an enormous $258 billion in Treasury bonds and bills supply. It concluded on Thursday when they issued $29 billion worth of seven year notes. Keep in mind this was for only one week. No wonder rates are creeping higher.
The other piece of the rising Treasury rate puzzle centers on foreign buyers. The largest foreign Treasury holders are the Japanese and Chinese. They have been aggressively selling off their holdings in recent months and buying less new U.S. federal debt.
The Japanese in particular have been liquidating a significant number of their foreign U.S. bond holdings. Japanese investors have been negatively impacted by the declining dollar as well as rising yields. Higher yields mean lower values for the bonds as yield and price are inversely related.
If the Japanese were to instead buy their own government bonds, this would increase the value of the yen still more and compound their problems. You can’t blame the Japanese investors for wanting to reduce their considerable exposure to U.S. debt now. You can prepare your retirement portfolio for the consequences.
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