As the US Treasury market was consolidating yesterday’s 7.5 basis point jump in 10-year yields when Bloomberg’s headline hit. The claim was that Chinese officials are “wary of Treasuries”. Yields rose quickly to test 2.60% and the dollar moved lower.

It is difficult to determine the significance of the claim as the Bloomberg story does not quote anyone. The “people familiar with the matter” who are cited are not identified, but claims that other officials who are reviewing the central bank’s reserves, have recommended “slowing or halting” purchases of US Treasuries.  

The report clearly spooked the market, but it is worth looking closer at the issue to see the forces that are at work. The first place to begin is the US Treasury market itself. With above trend growth and a tax cut on top of it, many looked for higher yields (lower prices) this year. The combination of less demand from the Federal Reserve, as its balance sheet shrinks by an accelerating pace from $30 bln in Q4 17 to $150 bln in Q4 18, and greater supply, other buyers will step up and it make take higher yields to incentivize.  

Speculators in the futures market are net short 10-year Treasury contracts for the first time since last April.  The switch is a function of gross long liquidation and accumulation of gross shorts. The former appears to account for about 2/.3 of the recent net position shift. Speculators have been short two-year Treasury note futures since last May. 

Also, we have been noting that the market-based inflation measures, like the difference between conventional yields and the inflation-protected securities (TIPS), have been rising. The 10-year breakeven is holding now above 2%. The two-year breakeven is 1.66%, which is an eight-month high.

Investors are aware that US yields have been trending lower since the early 1980s. The downtrend line appears to be coming in a little below 2.7% on the 10-year US yield. Some asset managers have already called the end of the generation-long bull market, and of course some made the same call a year ago. Others are waiting for some confirmation like a trend line to be violated.