Janus fund manager Bill Gross says that happiness has been dominating stocks while despair has taken over global bond markets.
"Watch the 2.6% level. Much more important than Dow 20,000. Much more important than $60-a-barrel oil. Much more important that the dollar/euro parity at 1.00. It is the key to interest rate levels and perhaps stock price levels in 2017," he explained in his January letter to investors.
Economic growth expectations have been lifting equities since the election of Donald Trump.
However, risks concerning higher inflation and a more hawkish Federal Reserve are why the 10-year Treasury has moved 100 basis points, from 1.40% to 2.40% since November.
"Are risk markets overpriced and Treasuries over-yielded? That is a critical question for 2017," Gross writes.
He acknowledges that the Federal Reserve is tightening, but points out that other central banks are conducting $150 billion of monthly buybacks.
This means global arbitrage "effectively caps the 10-year at 2.4% to 2.6% levels," he says.
Plus, there are "currency adjusted yield pickups" of 70 basis points — accomplished by selling 10-year Japanese government bonds or German Bunds and buying U.S. Treasuries — and this has led to the artificial pricing of the U.S. 10-year, "even as inflation moves higher and short-term yields are raised by the Fed once, twice, or three times in the next 12 months," according to Gross.
Rational Reality
These fundamentals can be confusing. But technical indicators show "a super three-decade downward sloping trend line for 10-year yields" that could prove to be critical to bond investors.
The Janus fund manager says that there are many influencing factors that "obscure a rational conclusion that yields must inevitably move higher during Trump's first year in office."
