US yields back at the heart of capital markets

It seems we are back to where we were in September, when the US ten-year treasury was centre of the capital markets.

Having been closed yesterday for Veterans Day, the ten-year bond has resumed its seven day sell-off, pushing to 2.77%, although it should get more attention in European and US trade.

Emerging market currencies likely to fall on a further sell-off in US bonds

With the Fed signalling that financial conditions were not a concern in its October statement, it will be feeling a bit hot under the collar that the benchmark bond is just over twenty basis points from where it was in September, when it hit 3%. The move has naturally benefited the USD, especially when German bunds have been anchored by falling inflation forces, and with a barrage of key Fed officials this week (including Janet Yellen), rhetoric around the bond market will be closely watched. Of course the pain trade will be felt most in emerging markets, and we have already started to see some moves in the space over the last five days or so; a move to 3% (on the ten-year treasury) will no doubt see speculators honing in on the likes of INR, INR, BRL and MXN again and selling. Traders will be looking for a further unwinding of carry positions in this environment as well, with the AUD under pressure.

Of course there will be winners here; any country that is trying to engineer a weaker currency either through a loosening of policy or pure rhetoric will be keen to see US yields underperform their own domestic bond markets, in turn seeing the yield advantage that US treasuries command increases (putting upside into the USD). It’s amazing what a good headline payrolls report will do, but clearly the market is honing its attention on the January meeting, although I personally sit in the camp that March makes just that little bit more sense for the Fed to cut back on the pace of bond buying.

March the more likely date for the Fed to taper

To me March seems more likely, predominantly because it gives Janet Yellen that bit more time to see what life is like at the top. Given all the recent focus that we could see the Fed strengthen its forward guidance with regards to the unemployment threshold to 6% or 5.5%, it makes sense to collate this with the March meeting when Janet Yellen has the associated press conference to explain the board’s actions in that much more depth. It’s also extremely interesting to see that the US yield curve has steepened by over twenty basis points since late October, but the Fed funds future (June 2015) has not even budged.

The positive aspect here is that it seems the market is sensing that this possible change in guidance would really hammer home the ‘separation trade’, i.e. that a tapering to the QE programme does mean that rate hikes are on the table. This could limit USD upside and keep equities bid.

In Asia today the focus has been firmly on China, with the country seeing a sharp slowdown in the level on new yuan loans provided in October (RMB 506.1 billion). A more hawkish tone has naturally been struck of late, although this shouldn’t surprise too many given the recent actions, while October traditionally sees a sharp slowdown from September anyhow. All eyes are on the Third Plenary meeting, which so far has seen media speculation around potential actions/reforms, but nothing concrete as yet.

One of key talking points has been around the EUR and AUD and whether there are further falls ahead against the greenback. From a fundamental perceptive both have priced in a lot of news and thus we have seen a number of traders positioned on the short side a bit off the table. In Australia we have seen a slight deterioration in business confidence, although the spread against business conditions has contracted marginally. AUD/USD fell on the back of this to a low of 0.9329 and seems to be chewing through bids between 0.9345 and 0.9326 (series of highs and lows from June 11). It’s interesting to see momentum indicators have turned negative here, although in the short term downside could be limited to 0.9327.

The ASX 200 saw initial buyers, with the index rallying 0.6% to (5420), but as the morning rolled on sellers moved in. Price action in the banks looks a little wobbly right now, especially with ANZ and CBA closing below Friday’s low yesterday. Mining stocks still seem supported, although the materials sub-sector is tracking sideways at present. Price action, at least from an index perceptive, looks lethargic and lacks a catalyst.

Ahead of the European open

Europe looks set to open relatively flat, although traders have been net buyers of our out-of- hours markets. The 1.7% gain in the Nikkei has been at the centre of this, however it hasn’t really been replicated by moves in US or FTSE futures, although they have moved very modestly higher. The focus from a stock perceptive has to be Vodafone given its 6.7% weight on the FTSE. The stock has enjoyed a strong outperformance against the broader market and overall telco space, and given its current valuation will need to come out with strong numbers.

On the data side we get final inflation numbers out of Europe, although these are not expected to change, while ECB members Ewald Nowotny and Jens Weidman are due to speak. EUR/USD is firmly in play, and like AUD/USD we have seen short covering. I feel moves up to 1.35 could be continued given the ECB’s easing bias.

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