Asian shares were fragile on Friday after benchmark US Treasury yields surged to a seven-year high and strong economic data fanned concerns about inflation and the risk of faster-than-expected interest rate rises. Treasury yield refers to the return on investment in a US government debt…
Asian shares were fragile on Friday after benchmark US Treasury yields surged to a seven-year high and strong economic data fanned concerns about inflation and the risk of faster-than-expected interest rate rises.
Background
Treasury yield refers to the return on investment in a US government debt obligation, such as a bill, note or bond. Treasuries are considered low-risk investments because they are backed by the US government. But the low risk typically means a smaller return as compared to other investments.
A bond is a fixed income investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate.
Economists have conventionally used instruments like inflation, lending rate, growth rate and national income to diagnose the health of a country economy. However, bond yield are gradually becoming a very prescient means of gauging the trajectory of an economy. As investors sell government bonds, the prices drop and the yield increases. Over the last few months, the bond yield has risen due to unfavorable macro developments on the domestic and global fronts. Domestically, the consumer price index (CPI) inflation rose to breach the 5% mark, driven mainly by higher food, fuel and housing prices. The yields have been steadily rising since the start of September as expectations for economic growth creep higher. Traders pointed to a revision in the retail sales as the reason for the latest push in the rates.
Analysis
The yield on the benchmark 10-year note hit a fresh seven-year high of 3.232 percent overnight following data released the previous day. The private payroll numbers were seen as boosting the odds that official US jobs data for September, would also be stronger than expected. MSCI’s broadest index of Asia-Pacific shares outside Japan fell 0.3 per cent, while Japan’s Nikkei dropped 0.5 per cent and Australian benchmark was up just 0.1 per cent.
Jeffrey Gundlach, chief executive of Doubleline Capital, told Reuters on Thursday that the 30-year US Treasury bond yield has broken above a multi-year base, which should lead to significantly higher yields for financial markets. With the 30-year Treasury note closing at 3.35 percent, the surge in the treasury yield has also prompted a rise in government bond yields across the globe, with a major exception being Italy since the borrowing cost dropped after the government reported that it would cut the budget deficit targets from 2020.
Bond rates rise when prices fall. In essence, yields are going up because investors are selling bonds. According to Jeff Mills, co-chief investment strategist at the PNC Financial Service Group, the spike in yields is due to increased hopes that Italy will get its budget problems under control and also because of the new trade deal the US reached with Canada and Mexico.
Wall Street stocks, in turn, have fallen broadly on Thursday, with the Dow suffering its first decline in six sessions and both the S&P 500 and Nasdaq seeing their worst day since June 25. The Dow Jones Industrial Average fell 0.75 percent, while the S&P 500 lost 0.82 percent and the Nasdaq Composite dropped 1.81 percent.
Japanese and euro zone bond yields rose sharply, tracking their US counterparts. The US dollar was steady but lingered near recent highs against the euro and the yen as investors assessed US economic data and Powell’s remarks. While the dollar index was flat, the euro experienced a slight change at $1.1517. The Japanese yen softened 0.1 percent versus the greenback at 113.98 per dollar.
On Friday oil prices rose, due to the scaling back of US sanctions against Iran’s crude export. US crude oil futures rose 0.7 percent to $74.85 a barrel and Brent crude futures gained 0.5 percent to$85.00 a barrel.
Assessment
Our assessment is that with the rising yield of US treasury bonds, investors would have to be cautious, amid the expectations of rising inflation, which may encourage the US central bank to tighten their monetary policy. With the economy continuing to add job, investors would have to scrutinise the wage data, which could precede a broader increase in prices throughout the economy.
We also feel that, from a global perspective, as the bond yield continues to rise in the US, the economy is becoming increasingly attractive as compared to other developed markets. From the perspective of valuation, however, a stable to weaker dollar seems more likely over time. We understand that while higher rate would often lead to a boost in the value of the US dollar, a stronger dollar often hurts overseas profits from giant multinational companies like Apple, Boeing and Caterpillar. We also believe that while the Federal Reserve is gradually raising its target interest rate by making borrowings more expensive, there is an increase in the cost of paying back existing debt that would slow spending – and the economy along with it.
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