Bond Yield Deviation: Countdown To QE Endgame Has Begun?

The Federal Reserve’s annual conference at Jackson Hole came and went without any material statements on Fed policy. The notable absence of Fed Chairman Bernanke from the conference and the fact that Vice Fed Chair and candidate for the Chairmanship Janet Yellen did not make any speeches failed to answer any questions about Fed policy and the timing of the taper of asset purchases. A Bloomberg poll finds 2/3 of the market anticipates the taper will be in the amount of $10 bln in next month’s FOMC meeting.

How’s it Different from End of QE1 and End of QE2
Some pundits argue that the sell-off in Emerging Markets will not impact the Fed’s decision on the size of the taper because previous decisions to end QE1 and QE2 did not impact those markets. But the difference between then and now is that both the end of QE1 (March 2010) and end of QE2 (June 2011) occurred during rallying emerging markets as those periods coincided with substantial decoupling of BRICs away from the debt crisis in the Eurozone and the debt/macro uncertainty in the G3 prevailing at the time.

Another reason why today is different (and more challenging) from March 2010 and June 2011 is the positioning of bond yields. Around the end of QE1 in late March 2010, US 10-year yields stood at 18-month highs near 4.0%, at their 200-week moving average. As for the end of QE2 in late June 2011, US 10-year yields drifted just below 3.0%, but were on a declining trend, well below their 200-week moving average. Today, yields are on a firm uptrend and well above their 200-week MA (2.54%). In fact, 10-year yields are 11% above their 200—week MA, the longest deviation since 2007. More importantly, it’s the longest “uptrend” deviation since 2006, ie the highest deviation when yields were in an uptrend rather than when they were on a downtrend such as in June 2011.

The implications of these vital pricing dynamics in bond yields suggest the countdown to QE endgame has begun. We have often been told by the Fed that tapering of asset purchases does not imply tapering. So may be the case if tapering takes place mainly in treasuries, rather than Mortgage-Backed Securities, but bond traders in the US and UK have already made up their minds as the charts illustrate.

Carney’s Wednesday Appearance
BoE governor Carney is due to make his first policy address tomorrow at 8:45 ET (13:45 BST) since this month’s speech on forward guidance. Many expect Carney to be dovish, aiming to talk down rising yields and reiterate the forward guidance with the 7% unemployment goal. But rather than chasing the market, this will likely prove to be only a temporary dip in GBP and gilt yields before a rebound is triggered off $1.5400 and 2.45%. The media may dub the appearance as another dovish speech, but to traders, it will be a “Carney fakeout”, before yields regain 3.0%.

Gulf Stocks Finally Take a Hit
Gulf stocks are taking a hit as fears of a strike on Syria are considered the biggest threat to the geopolitical landscape and global markets to date, since the outbreak of the Arab Spring in January 2011. Besides the uncertainties factor related to the details of a possible strike on Syria, the most dangerous unknown remains that of the Iran reaction via its militia forces in Syria and Lebanon as well as the repercussions of the Israel role in the region.

Gulf area have shrugged the tensions in Egypt and Syria as well as the selloff in emerging markets primarily due to: i) rising oil prices offsetting G10 downside currents; ii) Gulf nations’ improved external fundamentals and FX reserves relative to ailing emerging markets; iii) frontier-market status stands out from the curse of emerging market; iv) broadening shift from real estate to stocks in places like Saudi Arabia.

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