[ForexNews]

Long-term bond yields rose sharply again yesterday. The US 10 year yield is now close to 3.70%, 50bp higher than a week ago. The sell off came despite a successful 5-year US Treasury note auction. It had a bid-to-cover of 2.3 and once again indirect bidders were eager participants and snapped up 42% of the issuance. Mortgage rates have also risen: GSE rates are above the levels where the Fed first announced that it would purchase their debt. This is becoming a big problem for all asset markets. It raises issues about the effectiveness of QE - the rise in mortgage rates suggests that the Fed may need to increase purchases but that may raise the perceived likelihood of high inflation in the medium run. If yields remain high, or rise further, volatility, worries about medium-term inflation and the sustainability of fiscal are all likely to rise in the near term. Concerns about inflation may be exacerbated by the comments yesterday by Saudi Arabia's oil minister that the global economy is strong enough to withstand oil prices of around USD75-80. There is no glaringly obvious G10 currency to buy here in our view: increased risk should be good for the USD, but fiscal issues, inflation and higher oil prices are all bad for it. Commodity currencies may benefit but are likely to suffer from increased uncertainty. In the short run, risk may win out, with the majors outperforming. Longer-run though currencies which offer some protection against high inflation appear attractive. One thing seems highly likely: large FX moves lie ahead. Buying EUR/USD volatility is the best way to position at present.