Fixed income markets to dominate FX

11 January, 2018

The outstanding performance for equities which sent many major indices to record highs may have just paused.

Asian stocks were trading broadly lower on Thursday after Wall Street notched its first daily decline in 2018.  It was neither economic data nor earnings that prompted the declines, but rather the selloff in U.S. Treasuries which sent 10-year yields to a 10-month high. The jump in government yields was triggered by reports that China is recommending slowing or halting the accumulation of Treasuries. Although China has reduced U.S. debt holding in the past, we haven’t seen an announcement of this nature. However, China’s foreign exchange regulator stated on Thursday that the report could be based on erroneous information.

So far, it seems that the news from China is politically driven and an indirect message to President Trump who is contemplating trade sanctions against China as a response to the massive trade deficit. Given that the U.S. is poised to boost its debt in 2018 to fund the deficit widened by tax reforms, the result of China selling off a considerable share of its Treasury holdings, would likely precipitate the beginning of a bond bear market.

Treasuries steadied in Asia trade and 10-year yields declined six basis points from highs of 2.60%. Whether we’ll see another test of this critical level will likely depend on tomorrow’s U.S. CPI report. If the data surprises to the upside, market participants will have to adjust their expectations of Fed tightening. Although interest rate projections have so far impacted only the short end of the yield curve, inflation expectations will drive the longer end, thus, the inflation report tomorrow should be of great importance.

With the Cboe’s VIX trading below 10, investors seem unfazed by the spike in yields. However, another sharp spike in interest rates will bring equity valuations into question which may trigger a long-awaited correction in stocks.

Although higher long-term yields ought to be good news for the U.S. dollar, this is only true when they are moving for good reasons, such as economic expansion and the return of inflation. If news breaks that China slows or halts the purchase of Treasuries, expect the dollar to continue selling off, particularly against the Yen.

It’s a sad day for the Crypto world. Bitcoin, Ethereum, and Ripple all fell double digits on Thursday. After the Legendary investor Warren Buffett warned that cryptocurrencies would come to a bad ending, South Korea’s justice minister said the government was working on a bill to ban cryptocurrency trading. If the bill is passed by the country’s parliament, expect to see further selloff as more regulators are likely to join the clampdown on digital currencies.  


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