3% 10-Year Treasury Again In View

A 3.0% 10-year Treasury is again in view. To remind all, about two months ago the prospect of this benchmark was almost a certainty after a relentless climb from 2.4% at the start of the year. But a retreat ensued sending the 10-year as low as 2.72% in early April. Today, the yield is 2.92%, the highest in about eight weeks.

The accepted reason for the increase is greater than expected growth and inflationary pressures. I would like to add another… the massive impact of electronic based trading. The SEC states 99% of Treasury trading is done electronically utilizing algorithmic models.

I believe the next market crisis will not be an economic crisis, but rather a liquidity crisis. Liquidity is virtually absent given the changes in capital requirements and the inability of money center banks to take risk… aka hold inventories.

The regulatory entities are more concerned about speed of execution and risked based capitalization. Treasury trading has morphed electronically, which emphasizes speed, but not capitalization. What happens if there is a systemic event that causes a dramatic change in economic or monetary assumptions?

Liquidity is absent and prices could fall dramatically.

I vividly recall three periods of a radical change in sentiment… 1987, 1994 and 2008. In both 1987 and 1994, yields rose dramatically and 2008 yields fell dramatically.

What are the odds 2018 will be the inverse of 2008, but only on steroids given the lack of liquidity?

As noted many times, oil is at the highest level since December 2014, an environment few thought would unfold. Steel, aluminum, copper and lumber prices are surging, another unexpected event. Will demand pull inflation morph into cost push inflation?

Like many, I believe the secular bond bull market is over. However, I believe few have experienced a selloff in prices given that last one took place over 24 years ago. I read a statistic that average tenure of a bond trader is about 7 years and the number of bond professionals have dropped by over 60% because of technology; technology that I will argue does or cannot factor a systemic event.

As written before, it is all about speed of execution and market stabilizing forces are no longer available because of the long arm of government.

What will happen today?

Last night the foreign markets were mixed. London was up 0.44%, Paris was up 0.41% and Frankfurt was down 0.19%. China was down 1.94%, Japan was down 0.13% and Hang Sang was down 0.94%.