How quickly will bond yield rise once QE3 ends?

Here, we provide a preview of HedgeSPA’s newsletter –  HedgeSPA Market Scenarios May 2014.

The current U.S. federal budget deficit is roughly more than 5 percent of national income. A lion share of this deficit is financed by the U.S. Treasury Department’s additional issuance of U.S. Treasuries that are purchased by the Fed.  U.S. Treasuries are often regarded as the “safest” collateral used to backstop the financial systems, given the USD’s status as a reserve currency.

Since 2013, there has been a gradual fall in overseas purchases of U.S. Treasuries. The U.S. Treasuries market appear to be facing stronger headwinds due to factors ranging from the current Russia and Ukraine tension leading to Russia’s attack on petro-dollar, the mysterious drastic dumping of U.S. Treasuries in the recent months, to the latest minutes from the Federal Open Market Committee (FOMC) which suggested that the near-zero rate policy is here to stay, until the U.S. economy recovers with an inflation rate of 2%. In addition, the increase in the purchasing of Yuan-based assets by global central banks is hardly a source of comfort to U.S. policymakers.

With the benchmark U.S. 10-year Treasuries yield at its historical low, it is not unfair to ask how quickly yield would eventually have to rise once the quantitative easing program (QE3) ends, in order to absorb the enormous amount of new U.S. debt being issued.

In a joint press conference held by the U.S. president and his Japanese counterpart in Tokyo on April 24, President Obama explicitly stated that the US-Japan Security Treaty will cover territories administered by Japan, including the hotly disputed Senkaku/Diaoyu Islands.  Such comments are likely to become a point of tension with China.  Although China is motivated to protect the value of its massive stockpile of US Treasuries, we will not exclude any possibility that it may imitate recent Russian actions to put pressure on US Treasures as a reminder to the U.S of its addiction to Chinese financial support.

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HedgeSPA Research Team  – May 2014