The JGB market has not been cooperating with those who have been calling for collapse and hyperinflation; rather yields have marched from stupidly expensive to insanely expensive levels. At a 0.54% yield, the 10-year JGB is at a very interesting position.As I have pointed out before (when yield levels were slightly higher...), the payoff on an outright short position which can be held for a considerable period looks attractively asymmetric.
It's A Forward Story
What is interesting about the rally in the U.S. Treasury market is that it a story about the forwards. My crude proxy of the 5-year rate, 5-years forward has been marching steadily lower since peaking around New Year's. Meanwhile, the spot 5-year rate has been tracking sideways. Therefore, the rally has not been about revising the timing of rate hikes, rather it is a downward revision of "steady state" interest rates. This could be explained by a number of factors:
- Quantitative Easing (why now?);
- belief in Fed jawboning future rates;
- forward rate expectations slowly adapting to lower realised rates;
- demand for duration by liability-matching investors.
Although I believe that long-term rate expectations needed to be revised lower from the 5% average that held before 2012 as a result of the demand for duration, 3¼% may be too far. In any event, there is unlikely to be clarity until market liquidity comes back in September.
(c) Brian Romanchuk 2014