10-Year

· The higher-highs/higher-lows pattern since the 10-year yield trough in January is encouraging but the bigger test is the 225-230 area.

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From a price action perspective, the drop below the 50-day moving average and the failed higher-high, higher-low pattern are not supportive of an imminent up-turn in interest rates.

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This is the first time in the last year or so the 10-year yield has broken through, re-tested, and held above the 50-day moving average.

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The collapse in oil prices has brought down inflation expectations dramatically. Inflation will likely be the single most important driver of interest rates in the next 6-12 months.

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With the quantitative horsepower now available at the fingertips of even the most technophobic portfolio manager, there’s little tolerance for any model that finds itself out of sync. But “broken” models (and especially value-based ones) have an eerie way of reasserting their relevance just after they’ve been finally tossed to the trash heap.

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The sell-off in risky assets in early October promptly led to expectations of a more dovish Fed.

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As we expected, at 250-270, the 10-year yield stayed within our narrow target range in June.

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In the very short term, excessive bearish positions have been reversed so there is less downside pressure on interest rates. Over the intermediate term, incredibly low yields in the Euro-zone help cap the U.S. yield.

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We expect the 245-250 area, the upper bound of the previous lower range, to be a strong barrier.

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Given our assumption of no December taper and the fact that most of the recent rise in interest rates is due to an early-taper fear, we expect the 10-year yield to drop back to the 250 level.

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The “dual mandate,” which means the Fed is paying close attention to both inflation and employment, presents a clear dilemma for the Fed when it comes time to decide on a taper.

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We don’t think the numbers between now and the Fed’s December meeting will be strong enough to convince it to start tapering this year. No taper until 2014, in our opinion.

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A look at prior debt ceiling debates and patterns around resolution dates gives no surprises: markets are weaker in the two weeks before but stronger in the month after a resolution is reached.

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A look at prior debt ceiling debates and patterns around resolution dates gives no surprises: markets are weaker in the two weeks before but stronger in the month after a resolution is reached.

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More upside surprises are still likely and, despite the disappointing jobs report, the overall economic picture still supports a September taper. The improving economic picture is not just happening within the U.S., but in other major countries. We still believe the upside for the U.S. 10-year is limited.

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If interest rates keep going higher from here, we would run the risk of derailing a still-fragile recovery. As long as the Fed tapering uncertainty exists, we expect higher volatility on the 10-year yield to persist in the mean time.

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We think the 10-year yield will likely consolidate around 200-215 before taking a shot at 245. The 245 level looks like a strong barrier and will likely hold in the foreseeable future.

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