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Key events this week: Central banks vs. bond yields


15 March 2021

Three major central banks are set to hold their respective policy meetings over the coming days, though none are expected to announce significant adjustments this week:

Arguably, the single focus that investors will have is whether policymakers will deliver overt signs that they are willing to intervene and tamper down the spike in government bond yields. In recent weeks, we have written about how markets have been testing how much major central banks will tolerate rising yields. So far, markets are “winning”.

10-year Treasury yields hit a fresh high last week, closing above the psychologically-important 1.60 mark for the first time since February 2020. Yields on the 10-year gilts are at their highest levels since December 2019. Japan’s 10-year yields matched an October 2018 peak of 0.15 percent before moderating since, though still remains within the BOJ’s target range.

Why are government bond yields rising?

Central bank officials from the Fed and the BOE insist that those rising yields (which happens when investors sell off bonds and bond prices decline) are a sign of investor optimism surrounding the respective recoveries for the US and UK economies.

However, investors and traders have a differing opinion. They believe that inflation will make a roaring comeback considering the US$9 trillion in support that central banks have rolled out, coupled with an additional US$14 trillion in fiscal support from governments. More importantly, markets think that inflation will actually stick around, compared to the stubbornly meek price pressures before the pandemic.

Faster inflation could then see central banks tapering their stimulus support and eventually hiking interest rates sooner than expected in order to rein in raging price pressures.

Why are rising yields problematic for the economy?

Higher yields could lead to tightening financial conditions, which means that the flow of cheap money that had been rolled out since the pandemic becomes more expensive. And the tightening of financial conditions risks derailing the economic recovery, as households and businesses become less inclined to embark on debt-fueled economic activities.

How have markets reacted to the yields spike?

Investors have been selling off bonds at a drastic pace, which is causing those bond yields to rise. Those surging yields have also hurt tech stocks, while boosting sectors that have lagged since the pandemic, such as stocks in the energy and financial sectors.

This rotation sent the Dow Jones index and the S&P 500 to new record highs respectively on Friday, while the Nasdaq 100 still languishes 6.3 percent below its all-time high which was registered on 12 February.

Assets to watch this week

The futures for the Dow, S&P 500, and the Nasdaq 100 are in positive territory at the time of writing, suggesting gains when the US cash session opens on Monday.

Traders are set to react to any notable commentary from either the Fed, BOE or BOJ this week about government bond yields, especially statements that deviate from market expectations and indicate that these major central bankers are willing to stamp out unwarranted yield spikes.

Should markets actually believe the central bank’s rhetoric, that may dampen yields which could alleviate the selling pressure in tech stocks. Lower government bond yields relative to their peers could lead to declines for that nation’s currency, with the US dollar, the British pound, and the Japanese Yen in focus over the coming days.

#source

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