It was just a few weeks ago where I told readers to keep their eyes on the US 2 year yield and the 10 year yield. Both charts were moving coming off the Fed policy decision and the debt markets had some people stumped.
Jerome Powell was saying that interest rates were heading higher, but the markets were betting against the Fed as evident by the price action on the 2 year yield. I told readers what to watch for. I can now provide an update… and unfortunately, it may not be what traders and investors want to hear.
The Bank of Japan really moved global debt markets, and this was a theme I was warning readers throughout this year. The Bank of Japan continues to be the most important central bank for real estate and stock markets. Japan, not China, is the number one buyer of US debt, and since yields have been low in Japan for decades, Japanese money has been buying foreign bonds. In a way, Japan has in a way done yield curve control for the Fed and other Western Central banks (remember: buying bonds means yields drop and vice versa).
With the Bank of Japan adjusting their 10 year yield cap higher, many analysts see this as a surprise move from the dovish central bank. After months of not moving interest rates and seeing the Yen get hit as other nations raise rates, is Japan ready to do the unexpected? This sets up a very interesting scenario in the future. If Japan does start to raise rates, Japanese money may sell off US and European debt to come back home for domestic debt. For those saying Japan won’t do it, just a reminder that the European Central Bank and the Swiss National Bank raised interest rates out of negative interest rates. Something many analysts originally said wouldn’t happen.
Forget about the stock markets. The debt markets are what you want to be watching. Everything, including stocks, derives value from the debt markets. From the Bank of Japan, to central banks, and raising interest rates to tame inflation, the debt markets are going to be a top theme in 2023.
Starting with the 2 year yield.
Post Fed in mid December, the 2 year yield had some people scratching their heads. Even though Powell was saying more rate hikes and a terminal rate of 5.25%, the 2 year, which tracks near term interest rates, did not move higher. Instead, it looked like it was going to trigger a reversal pattern known as the head and shoulders. If triggered, the 2 year would head lower meaning the markets were calling the Fed’s bluff and thought they would not do more interest rate hikes.
But that reversal pattern did not trigger. We fought for days at the breakdown zone, but no breakdown. Rather, the 2 year popped and has broken out of a near term trendline.
This is bullish, meaning the 2 year yield is on trajectory to head higher. Meaning interest rates will still be heading higher.
The 10 year yield is rising once again, and is likely due to the Bank of Japan.
We are now approaching a very pivotal point for the US, the debt markets, and global stock markets. The 10 year yield broke below 3.90% way back in early November 2022. It triggered a breakdown pattern and falling yields were a positive sign for stock markets.
Post Bank of Japan, we have seen a rise in the 10 year which is now retesting 3.90% for the first time since the breakdown. Now this type of price action is normal. Retests are normal. However, if the 10 year yield closes back above 3.90%, then the current downtrend wave would be over. It would mean that the 10 year yield will also begin to rise.
Yields are rising in Germany, the UK, Italy and many more countries. The BoJ effect?
Rising yields mean lower stock markets, especially the Nasdaq as tech stocks move more with rising rates. Not surprised that the Nasdaq is currently testing near yearly lows. We could end the year with new lows, or start the year with a major breakdown.
My preferred market short is the Dow Jones. It is selling off right at its retest zone to the touch. The safer way to enter would be to wait for a close below 32,658 to make new recent lows. However, those with an itch for a short may find the Dow Jones provides a great risk vs reward short set up where it currently stands.
The debt markets will continue to be the most important markets to watch come 2023. The Bank of Japan really shook things up, and now some analysts are saying it may force the Fed’s hands. The Fed may need to pause or move up the terminal rate in fear of the Bank of Japan adjusting their policy even more. But this shouldn’t be the case since the Fed is all about taming US inflation. The terminal rate stands at 5.25% meaning rates will head higher. The first Fed meeting of 2023 will be a big one as many analysts believe a ‘pivot’ is coming.