Greece is a sideshow – watch US T-bonds instead

The prospect of Greece leaving the euro has grabbed the headlines, says John C Burford. But unnoticed to most, a bigger story is playing out.

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Crunch time has arrived. By the time you read this, it's very possible that Greece could be chucked out of the eurozone.

The media has covered this story in an interesting way. It is portrayed as plucky little Greece against the might of the Germans. Not Greece versus the eurozone mind you, but Germany alone.

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Many in Germany are calling for the nuclear option of pushing Greece out of the euro. That would mean blowing up Greece's financial system, the return of the drachma and default on almost all Greek debt.

Others want to paper over the cracks of the failed Greek state by extending and pretending in the usual eurozone fashion. That would require massive purchases of Greek bonds by the European Central Bank.

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But this is a trading blog. It's not a treatise on the political/economic situation in the eurozone thank goodness!

The question for traders is this: how should we trade the markets in a jittery week like this, if at all?

Greece is not the real story

For example, the dollar has been flying in recent weeks. And there's another market to which not many observers are paying attention.

That is the market for US Treasuries (or US Government bonds).

While the world had its eyes on the Greek debt negotiations, long-term US interest rates were shooting up.

For instance, the benchmark ten-year Treasury Note, which yielded just 1.6% at the start of this month, is now yielding 2.16% which means it's yielding 35% more than it was a month ago!

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If this is a sign of things to come, long-term rates are heading much higher. And that is a very minority opinion, I assure you.

Just about everyone has been complacently assuming interest rates will stay low for years to come under the influence of the central banks' zero interest rate policies, and plunging oil prices.

So, if deflation is assured, as so many believe, why are bond yields rising so rapidly? Surely, when deflation is here, bonds should rally. This is because a large component of long-term bond pricing is investors' expectations for future inflation. High inflation expectations means investors demand a higher yield (lower prices) to compensate for loss of future purchasing value of the dollar and vice versa.

So what is going on with the US Treasury bonds? Perhaps the market expects deflation to be temporary and inflation will resume its normal role pretty soon. After all, the central banks have a serious 2% inflation target baked into their calculations. Today, that target remains a distant dream, as it has for years.

By this time next week, the Greek drama might be over. But I suspect a much bigger, more dangerous phase will have just begun.

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