Bond Outlook June 8th

So now "everyone" believes USD 10-year rates will decline further, including Alan Greenspan and Stephen Roach. "Everyone" even includes ourselves, but with a key proviso: when the RMB is finally revalued, the resulting reduction in demand for T-Bonds should cause yields to rise. That is why we continue to believe a barbell is the appropriate strategy to deal with a rising Fed rate and further USD yield curve flattening. Flattening is likely to turn into inversion before the Chinese surprise us all with an overnight revaluation when all eyes are elsewhere.

Roach argues powerfully that economic rebalancing, assumed to be inevitable, needs both a lower dollar and higher interest rates in the USA to bring spending back into line with earnings. Recent dollar strengthening means that more of the burden of rebalancing falls on interest rates. He therefore sees the current fall in 10-year yields as a temporary phenomenon, although temporary can be several months. Greenspan cannot bring himself to admit that curve inversion implies a coming recession (as it always has in the past), although he is toying with the idea.