The tumult in bond markets is beginning to affect other financial assets. As 10-year US Treasury yields surge close to their cycle peak, riskier investments are taking a hit due to the increased appeal of the rising risk-free interest rate. The massive shift in US yields can be attributed to a confluence of factors: The Treasury's increased debt issuance to accommodate growing federal deficits, the Federal Reserve's program of quantitative tightening, and speculation about the potential of another rate hike given the robust US economic performance.
- Yields near peak, propelling the dollar.
- Gold and stock markets feel the impact.
- The yen's decline persists; will there be intervention?
Market indicators suggest a 40% likelihood of another rate hike by the Fed in November. This comes as the US economy shows robust signs of growth. The Atlanta Fed's GDPNow model predicts an annualized growth of 5.8% this quarter. These strong figures put Fed Chairman Powell in a spotlight ahead of the Jackson Hole symposium next week.
Dollar and Stock Market Dynamics
The ascending yields are benefiting the US dollar in two ways: via interest rate differentials and as investors seek safer assets. This has resulted in challenges for riskier assets like stocks. In layman's terms, the US economic growth trajectory is outpacing its rivals, potentially extending the dollar's upward trend. Interestingly, the dollar still lags behind the euro this year, which has been grappling with stagnant growth. The latest FOMC meeting minutes did not provide new insights.
The yield rally affected Wall Street as well, with the S&P 500 dropping by 0.76%, marking a five-week low. Given that corporate earnings have dipped from the previous year, the S&P's growth this year has been primarily due to multiple expansion. Notably, a significant yield increase can help adjust overextended valuations.
It's worth noting that the last time US yields were at comparable levels, the S&P 500 was 17% lower. While yields play a critical role, other factors, such as reduced recession worries and liquidity boosts, are influential. However, persistently high yields will make it harder for stocks to maintain momentum.
Gold and Yen Struggles
Gold prices, too, felt the sting of rising yields, dropping below the $1,900 mark and reaching a five-month low. This is due to the dual effects of escalating real yields and a robust dollar. Now trading below its 200-day moving average, gold faces a challenging technical landscape, with substantial support seen only around the $1,860 mark.
Meanwhile, the yen is on a downward spiral again, troubled by growing yield differentials and unfavorable trade conditions, especially with the recent surge in energy prices. While Japan intervened in the forex market to protect the yen last year, there's currently no clear indication of a repeat. The yen's decline pace is less alarming than last year, making intervention less likely at the moment. Yet, if the USD/JPY rate nears 150 rapidly, this stance might shift.
On the topic of foreign exchange intervention, Chinese banks have been actively working to stabilize the yuan's decline by offloading US dollars and purchasing their local currency. This comes in response to the People's Bank of China's recent rate reductions, which have put downward pressure on the yuan. The ripple effects are evident in the Australian dollar too, which has reached its lowest point against the US dollar since the end of 2022.
