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Bond yields have been driving the Dollar higher, but is that trade about to run out of steam?

Let’s take a quick look at a few charts and how that may be traded with USD/JPY.

10-year & 30-year Treasury Bond Yields

10-yr & 30-yr U.S. Treasury Bond Yields
10-yr & 30-yr U.S. Treasury Bond Yields

In case you’ve been away from the markets for a few weeks, rising bond yields have been the main driver across the financial markets, a function of the massive bond sell-off sparked by expectations that we’ll see a strong recovery from the pandemic and inflation worries.

As we can see in the chart above of the 10-year and 30-year U.S. Treasury yields, those yields have returned to the pre-pandemic levels. Could this be viewed as a signal that the recovery is fully priced in? Will the rally in yields be limited at current levels?

U.S. Treasury Bond Futures Daily

U.S. Treasury Bond Futures Daily
U.S. Treasury Bond Futures Daily

Bond prices may be able to answer the questions above (remember that a bond’s yield has an inverse relationship to a bond’s price), and looking at the daily chart of U.S. Treasury Bond futures above, bond prices have reach pre-pandemic levels.

Could the price of bonds be low enough now to attract traders looking for the safety of U.S. Treasuries at these much higher yields? Or how about traders who shorted U.S. Treasuries? Will they take profits at these levels?

How can forex traders potentially play that shift if it occurs?

JPY/USD vs. U.S. Treasury Bond Futures

JPY/USD vs. U.S Treasury Bond Futures
JPY/USD vs. U.S Treasury Bond Futures

Looking at the weekly chart above, we’ve charted the U.S. Treasury Bond futures against the inverse price of USD/JPY. We can see that there is a pretty strong correlation between the two markets, and in 2020, the turn lower in the Treasury futures preceded a return in strength in the U.S. dollar against the Japanese yen.

If the U.S. Treasury Bond market has indeed bottomed out, does that mean we’ll see the rally in USD/JPY come to an end?

USD/JPY Weekly: Resistance Ahead?

USD/JPY Weekly Forex Chart
USD/JPY Weekly Forex Chart

If the massive sell off in bonds has indeed run its course, then the Greenback’s short-term rally may be coming to an end as well.

Potential catalysts ahead that could solidify this scenario would likely be any data from the U.S. that shows inflation will not run rampant. This is highly debated at the moment with Fed Chair Powell signaling little worries, while notable investors like Michael Burry warns of hyperinflation ahead.

We’re on watch for the scenario that the coming inflation situation won’t be as dire as some fear (e.g., reads on CPI & PPI, labor market conditions, supply/demand conditions, money velocity, etc.), and if that scenario plays out, we’ll be on watch for bond yields and prices to stabilize around their current levels.

And if that bond scenario plays out then we’ll watch for bearish reversal patterns on USD/JPY at the falling trendline. In that scenario, a potential short position for a longer-term play of an unwind of recent market behavior makes sense.

Of course, if inflation does run rampant in the U.S. (reaching and holding well above 3% expectations), then we’ll consider a long USD/JPY position if bond yields continue to rise and continues to be the main driving theme for the financial markets.

What do you guys think? Is USD/JPY a sell now or is there more inflation fear to be priced into the bond markets and the U.S. dollar? 

Let me know in the comments below, and as always, remember to never risk more than 1% of a trading account on any single trade. Adjust position sizes accordingly. Create your own ideas and don’t simply follow what I do.

This content is strictly for informational purposes only and does not constitute as investment advice. Trading any financial market involves risk. Please read our Risk Disclosure to make sure you understand the risks involved.