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Last week saw something of an about-turn, or at least a temporary but significant adjustment, in recent financial market norms: namely that the 10-year Treasury yield, together with other comparable benchmarks, has risen at its sharpest rate since the US election. Stocks have also had their worst week in two years, and volatility, as measured by the VIX, finally rose from its historic lows. The expectation of tighter monetary policy is finally starting to weigh on broader market conditions.
Financial conditions remain historically loose, and the exceptionally low interest rates we have had since the 2008 financial crisis look increasingly at odds with the global growth and inflation picture. Indeed, this recent pullback in stocks is perhaps a healthy correction following the immense upswing that followed the corporate earnings season, asset allocation into equities at the beginning of the year, and Trump’s tax cuts buoying investor sentiment. On Friday, the release of US wage data showing that average hourly earnings are rising at an annualised rate of 2.9% (the highest this decade) was the trigger for yields to surge again, reaching almost 2.85%. To put this in context, in early September 2017 the yield was just over 2.00%. Just last week yields were up from 2.65% and the market is now aiming at 3.00%. From a historical perspective, this is still not a particularly high yield but it set the top for the benchmark at the end of 2013, the year of the ‘taper tantrum’. Nor is the US alone in this: eurozone yields also pushed higher with the German 10 year above 70bps, a level not seen since the end of 2015. Analysts are now considering the prospect of this benchmark hitting 1%.
Of course, whether this will actually transpire remains to be seen. The sell-off could be overdone already. Nevertheless, with three Fed hikes anticipated in 2018 alongside considerable issuance to pay for the deficit brought on by tax cuts, higher rates are at present the relatively accepted wisdom. The markets will certainly test Jay Powell as new Fed chair; the Treasury has to push out bond issues, largely at the short end of the curve, at the same time as the Fed has finally decided to reduce the size of its balance sheet and raise short-term policy rate - hardly ideal timing. The administration and Congress choosing to cut taxes at a time when the economy is at full employment implies that a lot of workers must join/re-join the labour market in order to prevent an overheating economy from producing high levels of inflation or a further bond market selloff.
Moreover, dollar weakness, a strong market conviction in January, will certainly be questioned given rising yields, the strong US economy, rates divergence and the tax reform. The strong jobs data on Friday saw the dollar rise considerably across the board, especially against emerging market currencies. Against sterling, the dollar now trades with a 1.40 handle rather than mid 1.43’s prior to the jobs data.
Meanwhile, global markets have started the week where Wall Street left off on Friday. Asian markets tumbled overnight, and the European bourses opened with Europe’s Stoxx 600 benchmark index falling 1% led by financial, tech and resource stocks. US futures point towards continued selling into the start of the US session. The FTSE, CAC and DAX are all in the red at the time of writing with the US dollar bid across the board.
For some years now, calling time on the US recovery has been as unprofitable as it has been popular amongst those fund managers wishing to make their names as contrarians. Few would now deny, however, that toward the end of 2017 markets felt more than a little tinged with euphoria. If so, history would suggest that corrections are on their way for a wide variety of asset classes – indeed, they may have already begun.
Upcoming Economic Releases
This week is an interesting one on the data front; services PMIs for the UK on Monday fell to 53 vs 54.2 previously, Draghi speaks in Strasbourg (Monday, 16:00 GMT), ISM Non-Manufacturing Survey in the US released (Monday, 15:00 GMT), RBA Reserve Bank Board Meeting – Monetary Policy Decision (Tuesday, 03:30 GMT), New Zealand Unemployment Rate (Tuesday, 21:45 GMT), Reserve Bank of New Zealand Rate Statement (Wednesday, 20:00 GMT), U.S. Crude Oil Inventories (Wednesday, 13:30 GMT), U.K. Bank of England Inflation Report, U.K. Official Bank Rate (Thursday, 12:00 GMT), U.K. Manufacturing Production (Friday, 09:30 GMT).
All views expressed here are the Author’s own and are based on information available at the time of writing.
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