Treasury yields at 1.6%: something to celebrate or to fear?

What to expect from the Fed meeting that could be a game-changer for financial markets

Treasury yields breached our line in the sand at the end of last week, and closed the week at 1.62%, the highest weekly close for 13 months. The driver was the official passing through Congress of the $1.9 trillion stimulus package from the Biden administration. If you want to score popularity points this is the way to do, according to a survey by Pew, 70% of American adults favours the bill. This is a huge proportion of the American public, and it suggests that consumer confidence, which has been flagging in recent months could pick up sharply in March. It also suggests that the route out of economic spare capacity for the US will be through a consumer-led recovery, which is good news for growth stocks – airlines, banks, energy firms, high end retail and non-essential consumer stocks – basically stocks that have not found much love from the investment community this year. 

What next for the dollar 

The stimulus bill and the surge above 1.6% for US Treasury yields are important for global financial markets for a number of reasons, firstly, the dollar. USD/JPY attempted to breach the 109 level at the end of last week, it marginally failed to do so, however, this pair is now at its highest level since June last year and we could see a push towards the 110 level, a key resistance level, in the coming days and weeks. However, what traders really want to know is when the dollar will stage a broad-based rally, so far, the dollar index has been stubbornly slow to react to rising bond yields. For example, EUR/USD made a decent recovery last week back to the $1.1950 mark, even though the ECB pledged to speed up its bond purchases in an effort to put the brakes on bond yield increases in the euro-area. Although yields rose in the US, the dollar index finished the week lower. Could the FX market be more sceptical than the bond market and the stock market, on the longevity of rising bond yields? 

Is gold still an inflation hedge? 

Interestingly, along with the dollar, gold has also been slow to react to events in the bond market and the dramatic rise in yields. The yellow metal remains just over $1,725 per ounce, which is close to the lowest level since June last year. The days of $2,000 per ounce back in August 2020 seem like a distant memory. However, gold is one of the oldest inflation hedges, with US inflation expectations at a multi-year high, and with consumer confidence set to surge on the back of the Biden stimulus package, what has happened to gold? 

We believe that two things could be keeping interest in the dollar and gold muted right now. Firstly, the market wants to wait to hear from the Fed, who meet on Wednesday 17^th March. Is the FX market and the gold market expecting a dovish Fed announcement? Although we don’t expect that the Fed will take any action, will the Fed chair Jay Powell, whose press conference is at 1830 GMT, use his rhetoric to talk down bond yields? This is the big concern that could keep markets on edge as we wait to hear from the Fed, arguably the most important event this week for financial markets. A dovish Fed = a weakening of the dollar, falling Treasury yields and further gains for tech stocks. However, what if Jay Powell isn’t that dovish? We believe that he is quite happy for Treasury yields to rise to this level and beyond, possibly to 2% by year end, as it does the work of tightening monetary conditions without the Fed actually hiking rates. If we are correct, and the Fed seem to tacitly approve of rising Treasury yields, then we expect more volatility for stock markets, with Boeing, along with airline and non-tech retail stocks, likely to be big winners in the second half of the week. We could also see the dollar rally come to life, along with a stronger interest in gold. 

Could the digitalisation of the globe send gold into retreat?

The second issue is linked to gold. While gold is a traditional inflation hedge, the world is shifting, and this lead to changing demand in the commodity space. Legislation across the developed world is trying to accelerate the move towards electric vehicles, which is turbo charging demand for the metals required to make car batteries, including nickel, cobalt and lithium. These commodities have seen their prices surge in the past year; the biggest lithium EFT has risen by 170% in the past 12 months. Gold is pretty, but it is also pretty useless and is not a necessary metal, aside from jewellery, in the digitalised world that we now live in. Thus, perhaps a better inflation hedge is cobalt or lithium going forward, Afterall, people still need to shift to cleaner cars in the coming years, thus demand for electric vehicles could become less sensitive to the economic cycle. Thus, even if we do see the Fed chair sound balanced about the rise in bond yields, gold may not make an attempt at $2,000 per ounce any time soon. 

Markets on edge as we wait for the Fed 

Overall, the Fed has some untangling to do when it meets on Wednesday. How can it remain silent on bond yields when this is the biggest theme for global financial markets right now? We expect emerging market stocks to suffer as a result of the breach of 1.6% in US Treasury yields at the end of last week, thus rising Treasury yields have global significance. Added to this, how can Powell and co. at the Fed tolerate fast-rising bond yields when annual core inflation data last month fell, and the inflationary impact from the stimulus package could be temporary? Also, while US employment growth was strong in February, there is still plenty of spare capacity in the US economy, and it remains to be seen if Biden’s stimulus plan will be a long-term job creator. 

Overall, as we lead up to this important Fed meeting, the markets are likely to remain in a pause mode. We don’t expect any big moves ahead of the Fed meeting on Wednesday, and any weakness in tech stocks could be bought into at the start of the week.