Powell put a pin in the bond bubble

Jerome Powell and more economic data underlying the strength of the US economy put the skids under global bond markets on Thursday. The US dollar rose to an 11-month high against the Japanese yen, on the back of this Emerging Markets had their worst day for 8 months. Jerome Powell, in probably one of his more hawkish statements, suggested the Federal Reserve’s monetary policy will move from accommodative, what he believes it is now, to more restrictive. This on top of strong employment data recording private payrolls rose by 230,000 in September, and the latest non-manufacturing Institute for Supply Management survey rising to a 21-year high. US 10-year treasury yields rose to trade at one point at 3.2%. The sell-off in bonds was not restricted to the US as yields in 10-year German bunds rose. However, at just over 0.5% they do remain very low compared to history. UK gilts were not immune as the yield on the ten-year gilt rose to 1.66%. 

The bond proxy sectors, stocks that are considered better investments for income rather than growth, tobacco, utility and telecoms for example fell as investors reacted to the move in bond markets.

Equity markets in America did climb higher on Wednesday on the back of the strong economic data, however, the Vix index rose over 13%, suggesting that some investors were prepared for a negative reaction from US equity markets to the fall in bond prices. So, it proved on Thursday. As we discussed before, equity valuations are partly driven by what can be obtained in the government bond markets. If treasury yields rise, valuations in the equity market will fall to compensate for the additional risk of owning equities. The much-debated US yield curve did steepen modestly as longer-dated yields rose more than those maturing in the next few years.

Italy remains a headache for Europe and whether a battle between the Italian alliance and the rest of Europe could be the catalyst for Italy to leave the euro. The leader of the five-star movement, Luigi di Maio said on Tuesday that the government will not retreat “one millimetre” from its budget plan. An article in Thursday’s Telegraph talks about a game of chicken, between the rest of Europe and Italy, similar to the one they played out with Greece. The article goes on to suggest that unlike Greece, Italy may be able to switch back to the lira without a financial crisis. One reason for this they gave is that Italy has a primary budget surplus. The article goes on to point out that should the  Italian government suggest reintroducing the lira this could lead to selloffs in Portuguese, Spanish and Greek debt markets, just as the ECB is finishing their bond purchase program.

Posted on October 4, 2018 .