These recycled official flows into US Treasuries, acted as 'a bond put' when the USD was weak.

And while the US yield curve is starting to move under the parameters of conventional economic forces such as treasury supply and demand, places like Europe and Japan are still toiling under an entirely different set of factors, namely central bank “jump risk” or concerns that central banks will no longer anchor the long end, causing another taper tantrum and/or VaR shock.

In the EUR area and Japan, the critical duration concerns relate to how aggressive Central Bank easing has severely distorted fundamental bond and credit value, and the uncertainties this fosters about 'jump' risk as and when they exit such distortionary policies.

The flip side of this is that as long as the expected USD exchange rate has shifted broadly neutral, US short-term yields are certainly high enough relative to a G10 peer group, to be extremely attractive without the need for investors to stretch out the curve and assume duration risk.

Ultimately, this boils down to a feedback loop whereby perceptions of a relatively stronger economy manifest in changes in the yield curve, which in turn leads to capital inflows, and a stronger dollar, are prompting the Fed to tighten further, creating expectations of even higher short-term rates, and even stronger inflows.

Categories: ZH