How US Bond Yields Are Linked to Equities, Commodities, USD
01/10/2018 2:05 pm EST
Events pivot around U.S. bond yields and what it means to equities, commodities and the USD. The correlations that drove 2017 aren’t working today. Maybe that is the horseshoe nail problem or maybe it is volatility returning, writes Bob Savage, Track Research.
For the want of a nail, the shoe was lost, for the want of a shoe, the horse was lost, for the want of a horse, the rider was lost, for the want of a rider the battle was lost and for the want of the battle the kingdom was lost – all for the want of a horseshoe nail.
Headlines driving today:
1) China officials are said to recommend slowing or halting buying in U.S. Treasuries.
2) Bill Gross confirms bond bear market – snap of 25-year trend.
Both are about bonds and they are the most irrelevant asset class since 2009 and the start of global QE. 10-year Treasury yield closer to 2.6%. Perhaps this is all changing.
I remember that proverb from my childhood, perhaps because of the illustration – it had an armored knight atop a fiery stead brandishing a sword – fodder for the imagination of how the modern world exists because we don’t have to worry about horseshoes anymore, or do we?
Causality and correlation aren’t the same and I wonder if that is the problem with the market today. The asset allocation theory that extends from observing the first week of trading in 2018 seems simple enough – buy equities, sell bonds, neglect the USD, embrace Emerging Markets and buy oil along with some other commodities.
The problems arise when you want to mix fundamental reasons behind the technical drift of 2018. The Stock Trader's Almanac will argue as goes the first 5-trading days so goes the month of January, and so too, the entire year.
The equity market embraces the global growth and U.S. tax reform stories and runs into 4Q earnings looking for great things – like 10% EPS.
Today that hits the wall of rates. The bond bear market call from Bill Gross thanks to the technical break out of the U.S. 10Y at 2.55% makes the search for a fundamental driver like Friday’s CPI report that much more exciting.
Today that extends on the threat of China not buying as many U.S. bonds to neutralize its trade surplus gains.
Of course, the real driver is the taper talk for the ECB and now the BOJ. Witness the relentless move in the Japanese yen (JPY/USD) stronger despite the US rate move higher – it’s because of the shadow taper talk, same is true for the euro (EUR/USD). The USD is down today after 3-days of modest gains – and that is interesting mostly because rates in the U.S. are higher.
Behind the scenes there is the role of China and its push for better financial regulation along with the blue-sky push to dampen polluting outputs even if it means less supply and buying less of the U.S. Treasuries in the process – China CPI is higher, PPI lower but lower than most expected – suggesting no need for harsher PBOC action – and so the PBOC has returned with open-market operations today.
Horseshoe nails should be cheap unless the smog kills the horse and the rider.
The minutes of the Swedish Riksbank and higher Norway inflation put the focus in Europe on the policy shift risks on the outside EMU players even as the data from the UK beats.
All of these stories pivot around U.S. bond yields and what it means to equities, commodities and the USD. The correlations that drove 2017 aren’t working today and perhaps that is the horseshoe nail problem or maybe its something bigger like volatility returning to all markets.