Asia Market: The bond market vigilante's return

Market Analysis / 6 Min Read
Stephen Innes / 04 Mar 2021

Market highlights 

  • The bond market vigilante's return triggered a jump in 10-year yields
  • More positive vaccine news primes US economy to shift into maximum overdrive
  • What started as a calm trading day for oil quickly turned into the running of bulls
  • MYR closes on a favourable tone after eased mobility restrictions; USD short unwind could continue

Markets

The bond market vigilante's return triggered a jump in 10-year yields to 1.47%, though it’s still lower than the recent highs of around 1.51% seen last Thursday. The S&P is down 0.8% heading into the close, but it’s more than double that in the Nasdaq.

Equities got hit with the inflation stick on Wednesday as technology shares felt the bond market vigilante's wrath after another spike towards 1.5% in US 10-year bond yields.

The selloff in global fixed income markets is revving up again, spilling over to unseat equities and other relatively heavily positioned risk-sensitive assets, leaving investors agog at just how soon the market is already testing the central bank policy thesis.

Chicago Federal Reserve Bank President Evans today did not push back on the rise in yields. He said he doesn’t see a risk of inflation rising too quickly or think the Fed will need to change the duration of QE purchases. To my mind, the only thing left that might influence the Fed's decision-making process would be whether financial conditions were to tighten or markets were deemed dysfunctional. 

Prospects for a rapid recovery in US consumer spending are increasing after the White House announced on Tuesday that it would have enough vaccines for every adult by the end of May, two months earlier than previously reported, which leaves the consensus forecast for 2021 US GDP growth of 4.9% much too pessimistic.

With the US economy about to shift into maximum overdrive, GDP could hit 7.5%-8.5%, buoyed by the vaccine roll-out and pent-up spending to come in Q2, so to any trained eye real yields are far too low ahead of a decisive period for economic growth.

The market focus remains worrysome on higher interest rates, a by-product of market-based inflation expectations, as well as the throughput effect into the heavily owned tech sector, where alarm bells are sounding amid lofty valuations.

Navigating inflation euphoria is no easy task as commodity base effects, fiscal stimulus and reopening coincide; it will be difficult to fight inflation enthusiasm and even more problematic for FX markets, as monetary and fiscal policy differentiation tends to be more pronounced heading out of a crisis than during a financial emergency.

Still, until a clear top lid gets put on bond yields, rate jitters amid higher volatility are going to be the order of the day. The Fed should not be in a rush to lean against higher yields, interpreting the rise as being justified by endogenous drivers like building optimism around the economic recovery. So, the Fed could willingly leave it up to the market’s self-correcting mechanism (higher bond yields) to ease sentiment back into the risk parity level where both higher bond yields and stock markets can exist in perfect harmony.

I guess we’ll remain in the bond market churner where rates go higher, which is scary when it happens too fast. Still, higher rates are fundamentally good economic news and a natural by-product of a rebound out of financial crisis and into normalcy and reflation.

And while the Fed is happy to let the back end move higher, I doubt they will ignore any aggressive movement in the front end 2022/2023 pricing.

Whether higher rates are good for stock indexes stuffed full of long-duration higher flyer bit-tech is one question. In contrast, WFH tech players are another as we near the selling window for profitable day traders who need money to pay for April 15 tax obligations.

Oil Markets

Oil prices jumped early on Wednesday following reports that the OPEC+ group could be contemplating the possibility of not increasing collective oil production from April as has been widely expected. So, what started as a calm trading day quickly turned into the running of bulls.

There was a massive build in oil stockpiles for the week ending February 26. After the freeze, a build had been expected, but not entirely of this magnitude – it was the largest build since 1982. Refinery runs were still well below average as many plants struggle to restart, hence the build. Gasoline demand, however, was the star of the show with a very welcome and colossal draw as the weather improved and road traffic picked up significant demand at 8.6mbls a day; it was back at mid-March 2020 levels when it touched 8.8mbld. Oil stalled for a few minutes after the data then started climbing.

But I think framing out the bullish vibe are the unambiguously positive recovery headlines around reopenings and vaccines in the US after President Biden said there would be enough vaccine doses for all American adults by the end of May.

The OPEC+ meeting on Thursday hinges on the gap between Russia's preference to add 1.5mbpd of crude oil production and Saudi Arabia's choice for adding 0.5mbpd. Perhaps more interesting is the lack of response of US shale to the higher crude oil prices.

Currency Markets

The Malaysian ringgit closed yesterday on a favourable tone after the government eased mobility restrictions. Higher oil prices should offset the climb in US yields to allow the MYR to trade withing its current range. Still, sentiment will remain prone to the broader US dollar reaction to higher US yields, especially if the US yield rise starts to outpace other countries’ bond yield bounce.

USDAsia has been reacting a touch negatively to higher yields and the ensuing wobble in risk sentiment. The selloff in US real yields last week breached "speed limits" where the critical risk for EM FX near term is how much higher USDCNY can go post-NPC. 

The US inflation reflation narrative is still alive, and the USD short unwind could continue. The Bank of Japan may surprise by stressing a commitment to cut rates further if needed. As a result, the market is going long via USDJPY as the cleanest hedge. 

Gold Markets

Gold continues to struggle, down over $200 since the start of 2021. If it fails to hold above $1,700 this week, the selloff may continue. Rising bond yields have been the most significant obstacle while overall economic conditions improve as the trifecta of Covid-19 vaccines roll out in the US. 

For more market insights, follow me on Twitter: @Steveinnes123 

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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