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Summary
- After weaker-than-expected US CPI last week, the 2-year US Treasury yield broke below the ~4.6% floor in place since early April. The yield remains below this level, having touched ~4.4% this week.
- Similarly, the UK 2-year yield has traded lower over the past couple months. The yield gained momentum over the past week, printing a marginal new year-to-date (YTD) low below 4% yesterday.
- US and UK short-end yields will likely avoid falling further in the next week. Little impetus exists for a drop until the next Federal Reserve (Fed) meeting (31 July), Bank of England (BoE) rate announcement (1 August), and US jobs report (2 August).
Market Implications
- As a result, we prefer to square up any remaining bullish positioning ahead of the upcoming event risks.
- We still like to buy US and UK short ends on price dips but anticipate better levels to enter.
US Yields Lose Downside Momentum (for Now)
On 11 April, when the US 2-year yield was trading very near 5%, we argued US yields, especially the short end, appeared stretched to the upside. We wanted to fade the rise by scaling into a received position in the short end.
We reiterated our buy-on-price-dips approach on 17 May, while also highlighting the ~4.6%/~5.0% range in the 2-year US yield. We correctly expected US rates markets to remain rangebound, with a downward bias in yields.
Chart 1: 2-Year US Treasury Yield = Orange Line
Square Up and Wait for Better Levels to Reinstate Longs
After we advocated reducing long positions, the US 2-year yield has lurched lower again, trading as low as ~4.4% this past week.
This is the lowest level since the first week in March.
Bilal Hafeez wrote this week on the importance of ‘event days’ for the US rates market.
Although we get US PCE on 26 July, the recent CPI and PPI releases last week implies few surprises up or down in US yields from next week’s PCE.
The next big event days for the US rates market will probably be the FOMC rate decision on 31 July and the US jobs report two days later.
Until then, we expect US yields to drift higher, given the lack of event-driven headwinds.
Technicals and Positioning Suggest Yield Retracement Higher
Our conviction on upward retracement in US yields is strong given market positioning and technicals.
The RSI reading for the US two-year note future (TU) is now above 70, meaning the TU future is now ‘overbought.’
Moreover, real money long positioning in TU is at extremes.
Combined with the lack of event risk, this positioning and technical backdrop prompts us to square up and await better levels to reinitiate long positions.
UK Yields Have Also Lost Downside Momentum (for Now)
On 10 May 2024, we argued there was potential for the 2-year UK gilt yield to trade down to 4%, which we reiterated on 14 June.
Chart 4: 2-Year UK Gilt Yield = Orange Line
It has been a bumpy ride lower for UK short-end yields this year (Chart 4). Nonetheless, the 2-year gilt yield printed a YTD low this week.
Given lack of ‘event days’ before the next BoE rate announcement on 1 August, plus the likelihood of US yields drifting higher next week, further downside in UK short-end yields in the near-term is limited.
As with the US short end, we square up all risk and await better levels before positioning for lower UK yields.
Richard Jones writes about FX and rates markets for Macro Hive. He has traded and invested in interest rate and FX market portfolios spanning three decades, both on the buy-side and sell-side.