Dec. 9, 2013
Last week I sent around a chart comparing real (CPI-adjusted) government bond yields in several developed markets, showing the significant divergence between the U.S. and Japan in recent months. 
Isolating these two markets and charting their historic spreads highlights this divergence, and shows that on an-inflation adjusted basis, U.S. Treasuries are about the cheapest they’ve been relative to JGBs since the Asian currency crisis some 15 years ago.
Over the past few days, however, both JGBs and Treasuries have shown some reversal signals that may indicate a change in trend is now underway.
On Friday, U.S. Treasury markets staged a strong bullish reversal after briefly making new local lows in reaction to the November employment report. March Ten-year futures initially fell more than half a point before quickly recovering all of their losses and ending the session exactly where they were before the data release. This emphatic rejection of new lows indicated that the market is no longer so bearishly inclined, at least not in the near term (Chart 3).
Position and sentiment studies also suggest that some short-covering in Treasuries may be due. Net speculator positions in ten-year contracts are approaching 200,000 lots short, a level that has historically shown a strong tendency to fuel short-covering rallies.
Both the JP Morgan and Stone & McCarthy investor surveys show real money institutional investors are short their duration benchmarks as well, while the DSI indices confirm a prevalent bearish sentiment in Treasuries. With year-end approaching, perhaps some of these bearish investors may soon decide to reduce their short exposure, lest a squeeze catches them wrong-footed in an illiquid market.
On the other side of the world, however, an entirely different reversal now appears to be afoot. With Japanese Government bond yields meaningfully lagging the recent rise in inflation, investors finally appear to be stepping back from their Abenomics-fueled bullishness. On the charts, JGB yields now appear to have completed a “cup with handle” basing pattern just above the 61.8% retracement of their huge April/May bearish reversal, while also convincingly breaking out of their six-month corrective trend.
The case for additional Treasury gains and JGB declines looks very compelling to me, and I anticipate adding to this trade on further confirmation of the reversal in coming days. Considering the positioning imbalances and the historic relationships between these two markets, I think there’s scope for a very significant profit over the coming months.
Happy Trading,
D
