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Why 3% May Be the Ceiling for US Treasury Yields

Why 3% May Be the Ceiling for US Treasury Yields

Kathy Lien, Technical Strategist

US Treasury yields seem certain to reach 3% (and soon), but market expectations for Fed tapering and formal intervention by the Fed are likely to keep yields from rising much further beyond that level.

The US dollar (USD) continues to trade higher against most major currencies this morning with USDJPY leading the gains, giving investors hope that the currency pair is finally waking up to the rise in US Treasury yields.

Although the slightly softer weekly jobless claims report erased earlier losses in Treasuries, investors around the world have their eyes locked on the 3% target for ten-year yields.

Yesterday's Federal Open Market Committee (FOMC) minutes basically confirmed that there is enough support inside the central bank for a reduction in asset purchases this year, so as long as US data isn't terrible, it should only be a matter of time before yields test 3%. However, further moves beyond that rate could be limited for two reasons:

1) The market has had plenty of time to price in tapering this year, and…

2) The Federal Reserve will do everything in its power to prevent a sharp increase in yields, especially since US data has been far from inspiring

While the latest PMI numbers show a stronger recovery in the Eurozone and China, US manufacturing activity expanded at a slower pace according to Markit's PMI report. Jobless claims also rose to 336k from 323k, while continuing claims hit 2.999 million, up from 2.970 million. Even with the increase, however, jobless claims remain at healthy levels, as evidenced by the four-week moving average, which dropped to its lowest level since November 2007.

Fewer firings may not translate into stronger hiring, but for the Fed, this report won't raise any new concerns about labor market activity.

Elsewhere, house prices grew at a slower pace in June, but the increase was stronger than expected and the past month's report was revised higher. The Fed sees a continued recovery in housing this year, and today's data confirms that. The dollar sold off slightly after these reports, but it is still looking strong against many of its major counterparts.

The Fed’s annual monetary policy symposium in Jackson Hole begins today and goes to Friday. We will be on the watch for comments from policymakers, but market-moving comments should be limited because Fed Chairman Ben Bernanke won't be in attendance. Actually, two months ago, Bernanke dismissed the significance of the meeting by saying, "There's a perception that the Jackson Hole conference is a Federal Reserve system-wide conference; it's not," and for this reason, no fireworks are expected.

USD/CAD Breaks 1.05

Meanwhile, USDCAD broke through the 1.05 level after Canadian retail sales dropped 0.6% in June. Economists had expected a 0.4% decline, and stripping out autos, they believed sales would be flat. Unfortunately, core retail sales dropped -0.8%, which was more than the headline report.

Part of the decline in consumption can be attributed to the floods in Alberta, but steep job losses and a recent downturn in Canadian data suggests that labor market weakness is indicative of a broader slowdown in Canada's economy. On balance, retail sales are expected to provide a smaller contribution to GDP growth in Q2.

Eurozone Recovery Is Imperfect, but on Track

Across the Atlantic, the euro (EUR) failed to hold onto its earlier gains despite stronger Eurozone PMI numbers. According to the latest reports, manufacturing and service sector activity in Germany expanded at a faster pace in the month of August, helping to boost activity in the overall region.

Despite muted French PMI numbers, this was the first time in 18 months that Eurozone manufacturing and service sector activity expanded together. These improvements confirm that the Eurozone recovery is still underway even if there may be some pockets of weakness in the region. So while we still need to see additional improvements in PMI to call this a new growth trend, the data is moving in the right direction.

See related: Dandy Data from Around the World

By Kathy Lien of BK Asset Management

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