Last month is considered “fait complete” for the three-decade bond rally. Investors have pulled more than +$11B from U.S. bond funds since Trump’s victory on the markets “reflation” trade. U.S 10-year yields have climbed +56bps to +2.38% in November, the biggest monthly jump in seven-years.
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.
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.
The recent pronounced upward movements in U.S. Treasury yields at the long end of the yield curve signal that the fundamental drivers affecting Treasury yields have shifted for the first time since 2013.
The vertical assault in reaction to the "shocking" Trump election, and after a 35-year Bear Market in YIELD, has propelled YIELD into heavy and consequential resistance between 2.25% and 2.50%, which will require robust economic growth to successfully penetrate and hurdle.
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)
The BOJ intervened last week in the local debt market to buy short-term securities to stabilize the market and resist the upward pressure being exerted by the rise in US rates. Despite the negative yield environment, Japanese banks recently report strong earnings. The rise in interest rates is seen as a favorable development among Japanese bank shares too. The Topix bank index has risen about 27% over the past two weeks.
... the yield spread differential between US Treasuries and JGBs stays supportive of the buck, especially after the BoJ introduced its ‘yield control’ back in September.
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.
The main driver [for the USD/JPY rally] is the rise in US yields relative to Japan. The US 10-year premium over JGBs is 2.12% today, the most in 2.5 years. It was at 1.55% as recently as early-September.
German Bunds and other European Bonds
In a recent speech*, Peter Praet, the chief economist of the ECB, stated that “the longer the current low-interest rate environment persists, the greater the challenges for bank profitability will be” adding that “the underperformance of bank equities may actually be testament to such concerns”.
Since the referendum announcement day (April 2016), the Italian government bonds remained constantly under pressure and the underperformance of the Italian 10Y generic BTP versus the Spanish 10Y generic BONOS, is a clear sign in this sense.
Featured Quotes from our Contributors
China is the second-largest holder of Treasuries after Japan but at the moment someone is clearly selling. Perhaps it's one of the Asian powers? We won't find out for months but Treasury-holdings data in the months ahead is must-watch economic news.
In sum, there is a roughly 1 trillion euro gap in expectations about how many bonds the ECB plans to buy. To us, that could represent a tremendous skew in market outcomes. If that isn't fully priced in and the ECB continues to buy, it's only likely to keep sovereign yields pinned at or slightly lower than current levels. There truly is a limit to how low you can go. On the flipside, if 1 trillion euros of buying is priced in and the ECB doesn't deliver, yields could rise significantly and the euro along with it.
...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.
While everyone has their eye on the Federal Reserve, it’s really the inching up of LIBOR that should be scaring market observers.
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."
... demand for government bonds from the public and foreign central banks dries up while the government’s borrowing needs grow ever larger.