The trend of European Yields

The chart shown on the left below is the German/Japanese 10 year spread. It’s also been trending below it’s 55 week moving average since May ’03. The spread trending in favour of Japanese rates (against European).

• In November ’05 the spread held at the 55 wma. The sharp widening of the spread in favour of Europe in November saw the spread move to and hold exactly at it’s 55 wma.
• However, this time around, the market is moving significantly “above” it’s 55 wma, which stands at 195 basis points German yields over Japanese, with a very large gap to the 200 wma which stands at 267 basis points German yields over Japanese.
• The 200 wma will become the target for the spread if a close can be achieved this week “above” the 55 wma (i.e. a spread in favour of German yields of 195 basis points or greater), i.e. targeting a move of 72 basis points in favour of European yields. Another chart pointing towards the potential for higher German (European) yields.
  

The charts shown on the right are both the German/U.S. 10 year spread. This spread is not so close to pivot points, and they are less well defined. However, the price action seen against the lows does argue that the spread is moving towards an extreme in favour of U.S. yields. This is again because of a 76.4 retrace, which we commonly see at market turning points. The extreme on the spread hit earlier this week at 116 basis points U.S. yields over German was a near perfect 76.4 retrace against the extreme hit last October at 121 basis points U.S. yields over. Although the 55/200 wma relationship is not as clear here, this is extra good evidence that significant further “widening” of the spread in favour of the USD is unlikely.

This is interesting given recent developments on the components of the spread. U.S. 10 year yields have just broken above LT resistance 4.63-4.70%, with next resistance 4.90% (highs from May ’04) but clear ability to move significantly further with the top of the multi-year channel on U.S. 10 year yields coming in at 5.28%. If the 10 year German/U.S. spread looks unlikely to move significantly further in favour of U.S. yields, and U.S. yields look to be going higher, so must German (European), possibly at an even faster rate.
( Source: Citigroup)