Everyone is so focused on interest rates. Too focused. The thing is, they’re focused on the wrong interest rate. While the federal funds rate has seen little movement and may not budge much for the rest of the year, three-month LIBOR is at multi-year highs!
Bonds within the Intermaket Picture
Bond prices and bond yields trend in opposite directions. This is important for understanding most of the analysis and news published on this page. It's also important to know the underlying dynamic on why a bond's yield is rising or falling: it can be based on interest rate expectations or it can be based on market sentiment -uncertainty- and a "flight to safety" to bonds which are traditionally considered less risky.
The rate of change of interest rates, either the target rate or market rates, is important because this causes either stocks or bonds become more attractive. When this happens prices will tend to trend as money flows from one vehicle to the other until the new relationship is adequantely reflected in prices.
Bonds and stocks are always competing for investor money, and less so commodities. These usually trend in opposite direction of bond prices (falling commodity prices usually produce higher bond prices, vice versa); therefore, commodities would trend in the same direction as interest rates.
If you are trading USD based or quoted pairs, watch the US bond market since a movement in Treasury yields impacts the US dollar. The driver of many movements in Treasury yields are partly driven by comments from Fed officials, so pay close attention to any news coming from US monetary authorities. US stocks usually get a boost from rising bond prices (falling Treasury yields), specially in inflationary times. But if they don't, then it's worth looking for market sentiment and reasons why the equity markets appear to be taking a more cautious stance. US stocks prices can also rise with falling Treasury prices (with rising yields) during a deflationary environment. In this case stocks and interest rates rise together which spurs global demand for the US Dollar.
The key driver of the dollar rally in recent weeks has been the rise in Treasury yields. We believe the driver of the sharp decline in Treasury yields on Monday was partly driven by fairly dovish comments from the Fed chair and vice-chair in recent days.
In this segment, Nicole Elliott, Private Investor and Technical Analyst detail the divergence between the Fed funds rate (currently at 0.5%), Treasury bills and interbank lending. Elliott says the yields on the Treasury bills are far lower than the Fed funds rate, while the interbank lending rates are at least 50 bps above the Fed funds rate. She calls this as the failure of the Fed policy. Elliott then goes on to detail the dynamics of overnight offshore Yuan lending rates.
Indeed according to Deal logic, global debt issuance is up 5.02 trillion dollars so far in the first three-quarters of 2016; this would put it on course to rival the all-time high of $6.6 trillion hit in 2006.
...And the dollar is at risk, so to speak, from other yields.
Since the July lows, 10-year Treasury yields have jumped about 22%, a big number for sure. However, a move from 1.3% to 1.6% is not exactly a huge deal in terms of borrowing costs.
Global bond prices tend to move in synchrony. But there are moments when a country's bond market experiences a sharper movement than other bonds markets. Sometimes it may be a currency movement: The Gilt is the 10-year benchmark in the UK fixed income market. It's correlation to the Sterling is usually positive and a decoupling between both markets serves as an early alert that some intermarket relationship has changed. Changes in foreign exchange prices can overwhelm relative return calculations for international investors buying Gilts as an investment. When stripped out the currency component, UK Gilts should still provide some return to investors otherwise other bond markets, Treasuries for instance, may become attractive.
It is also true that a prolonged trend in energy prices is also a factor to consider as it will affect inflation expectations and thereby BOE's monetary policies.
The point [of the illustrattion on the right] is simply to confirm what we know, and that is that recently UK rates have risen while sterling has fallen. We think this is meaningful.
Yields, or rather relative yield differ entials, are not the only deter minant of a currency's level but can be a big factor.
Interestingly, the UK gilt curve is also following the political path. The 2-year spread between UK and US yields is in negative territory, which is also weighing on GBP/USD (see the chart below). The bond market seems to be betting on a dovish response from the Bank of England to cushion the blow from the Brexit fallout.
Japanese Bonds (JGBs)
Mr. Harada said the BOJ would purchase more JGBs when a positive shock occurs (upside pressure on yields increases), which could add stimulus (Kyodo). On the other hand, when a negative shock occurs (downside pressure on yields increases), the BOJ could keep the pace of JPY80trn JGB purchases, allowing yields to decline. The potentially counter-cyclical nature of the new policy framework when negative shocks occur is viewed as a downside risk for USD/JPY, and asymmetric policy responses could be viewed as positive for risk sentiment, while further clarification is necessary. Mr. Harada also said it is good to create some steepness in the yield curve and the recent rise in 20yr yield is healthy.
Yujiro Goto, Research Analyst at Nomura, suggests that expectations for an immediate BOJ easing are low according to the latest JCER survey.
Spokesperson from Japan’s Fukoku Mutual Life Insurance Company was on the wires last hour, via Reuters, noting that they will continue to invest in foreign assets and ETFs, while refrain from investing in JGBs.
At the press conference, ECB Draghi prepared investors and markets that communication at the December meeting will shape monetary policy in the weeks/months ahead.
The Bund cheapened in ASW spread terms going into the auction and trades normal at the very long end of the German yield curve. We fear that the recent surge in yields will only attract a limited amount of additional buyers so demand might remain lacklustre.
Featured Quotes from our Contributors
...it’s no longer just sovereign debt that offers a negative yield. According to Bloomberg, French drug maker Sanofi just became the first nonfinancial private firm to issue debt at yields less than zero. Also, shorter-term notes of some junk-rated companies, including Peugeot and Heidelberg Cement, are yielding about zero percent.
The Fed is trying to tighten slowly… very slowly and at the same time provide stimulus by talking down the US dollar.
... demand for government bonds from the public and foreign central banks dries up while the government’s borrowing needs grow ever larger.
For the past six months, we have stated that the Fed would not raise rates prior to the election based on geocosmic factors (and practical ones), with the idea of supporting a “wealth effect” for U.S. citizens via a rising stock and bond market.
Not only is the DXY V Fed Funds rate completely disconnected but the best the relationship can achieve is + 65% to + 74% on the high side and minus 0.19 to 26 on the low side. Overbought Fed Funds is driving the misaligned Correlations.
...In sum, the bond market still does not believe the Fed is on a sustainable hiking trajectory. It may even be "one and done."