US bond yields rise as traders look to rate rises
05-10-2021
George Lucas, Raiz Group CEO
This week the focus is on the US where yields on bonds are rising (so the value of bonds is falling) and equity markets are not performing that well. The direction of the US equity and bond markets is leading the global market down even though Australia’s equity market did not fall as much in September as the S&P500.
We will also see the release of anticipated US jobs numbers. Traders are looking to see strong payroll gains for September after soft August numbers when just 235,000 jobs were created. I expect around 500,000.
On bond yields, the catalyst for the latest leg up could be delayed reaction to the hawkish US Federal Reserve meeting a couple of weeks ago, with the ongoing surge in oil and gas prices (read energy). Or it could just be that yields are unsustainably low, given the medium/long-term economic outlook.
Current market pricing seems to imply that the Fed Funds Rate — the interest rate at which banks and other depository institutions lend money to each other — will increase only very gradually over the next decade, while at the same time, investors seem not at all concerned about the inflation outlook.
To me this does not make much sense especially with supply side changes during the pandemic lifting the chances that there will be more lasting inflationary pressure in the US over the rest of the decade.
Lasting COVID-19 impact on labour supply
On this front, evidence is already emerging that coronavirus will have a lasting impact on labour supply via accelerated retirements, labour shortages in the services sector, as well as speeding up the process of decoupling from China, especially for countries like Australia.
For us at Raiz it means that our fixed income ETF could continue to fall while the US yields increases. At very least, we will likely not see the same capital performance from fixed income ETFs.
What it also means is that we expect the US dollar to continue to rally as both short and long-term interest rate differentials have shifted in favour of the USD, especially after the Federal Open Market Committee (FOMC) delivered another hawkish message at its policy meeting last week.
The greenback (USD) has also probably received some support from a decline in investors’ appetite for risk and a move away from China linked commodity currencies.
Still on currencies, the pound sterling has also fallen sharply against the US dollar perhaps reflecting, in part, uncertainty surrounding fuel and food shortages in the UK.
The shift in risk appetite and China connection is not going to help currencies like the AUD, Indonesian rupiah or Malaysian ringgit.
Global equity markets fall
Rising bond yields and a strengthening USD are likely to continue, which is not good for equities. Also weighing on equities are increasing signs of a slowdown in the pace of the global economic recovery, alongside hawkish shifts from major central banks to hike rates.
The falls in global equity markets over the last week of September rounded out a poor third quarter for markets and the MSCI World Index saw its worst quarterly performance since Q1 2020.
All this does not bode well for October as it would have been better for the markets to be volatile earlier on in September. Without a major catalyst I believe we have seen the largest gains in equity markets for a while.
In Asia, Chinese markets are closed until Friday for the National Day holiday. The week-long break could give power plants some much needed breathing room to help replenish their coal inventories and reduce the blackouts that have been occurring, but also ease the flow of news on corporate bankruptcies to markets.
In Japan, the Liberal Democrat Party’s Fumio Kishida will formally become Japan’s new Prime Minister. He has given mixed signals on fiscal policy and is unlikely to prioritise structural reform.
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