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2 Very Troubling Trends Unfolding Quietly

2 Very Troubling Trends Unfolding Quietly

Kathy Lien, Technical Strategist

The steady rise in US Treasury yields near the 3% level has many wondering about a potential bubble burst. Meanwhile, Japan’s record trade deficit shows the continuing struggles of the nation’s economy.

It may be the dog days of summer, but there is a quiet trend underway in the financial markets: US ten-year Treasury yields have now increased in five out of the last six trading days, reaching a two-year high of 2.89% intraday. Now, the 3% mark is within striking distance and there is a reasonable chance that bond traders will make that their target.

The bubble is deflating in bonds, leading investors around the world to wonder if the bubble is finally bursting. Talk of a bursting bond bubble has been happening for years, but it was only in the past four months that we’ve seen some significant moves in Treasury yields.

The bond bubble was created by the Federal Reserve's massive quantitative easing (QE) program, and the recent selloff was triggered by the central bank's discussions about reducing the amount of monthly bond purchases.

If the bond bubble bursts, it won't be pretty for equities, currencies, or the US economy, which is exactly why the Fed will do everything in its power to avoid it. The higher US yields rise, the stronger and more vocal the central bank could become in its commitment to buy bonds.

While we still believe the Fed will taper next month, we also feel that it will vigorously downplay the significance of the decision purely to bring about two-way action in yields. Perhaps it is that possibility that’s been limiting the movement in currencies and equities in recent days.

The dollar rose against some, but not all major currencies on Monday, and US stocks were down only slightly. No US economic reports were released, and there are no market-moving releases on the economic calendar for Tuesday, either. That will leave the focus squarely on US yields, and for the time being, we expect yields to test 3%, which should lend support to the US dollar (USD).

Japan Posts Record Trade Deficit

Monday was also a mixed day for the Japanese yen (JPY), which held steady against the US dollar, strengthened against the commodity dollars, and weakened against the euro (EUR), British pound (GBP), and Swiss franc (CHF).

Considering the continued move higher in US yields, we expected USDJPY to trend higher, but unfortunately, there has been very little upside momentum in the pair of late.

See related: 5 Roadblocks for the USD/JPY Rally

The latest Japanese trade numbers were the most important event risk released over the past 24 hours, and the data showed the country's trade deficit ballooned in the month of July, reaching JPY 1.024 trillion from JPY 182.3 billion the month prior. This was the largest deficit on record and illustrates the improvements in Japan's economy and how JPY strength in July affected trade activity.

See also: The 3 Biggest FX Event Risks This Week

Japanese exports rose 12.2% in July, while imports jumped 19.6%. As an export-dependent economy, Japan needs a weaker currency to fuel a stronger recovery. So far, we have seen very little improvement in the export sector, and because of that, the Bank of Japan (BoJ) still has a long way to go in its efforts to stimulate the economy.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.