A sell-off in the bond market sets the tone in the financial markets, including for currencies. The equilibrium is unlikely to return until the return on the benchmark’s 10-year US Treasury reaches 2%, a well-known analyst said Friday.
“There will be no peace until the US 10’s reach 2%,” Kit Juckes, global macro strategist at Société Générale, said in a note.
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A few auctions of US Treasury bonds, which have been a source of nervousness, went off without major problems over the past week, with yields settling into a new and higher margin, Juckes said. But with the S&P 500 index closing on a record Thursday, the return on the 10-year note is TMUBMUSD10Y,
has been reduced to above 1.6%, weighing on equities.
Rising returns have led to a rotation from growth-oriented stocks, including large-cap stocks and technology-related stocks, to more cyclically sensitive and often value-oriented stocks and sectors. The technically demanding Nasdaq Composite COMP,
slipped in correction territory, defined as a 10% drop from a recent peak as yields continued to rise as the S&P 500 SPX,
and Dow Jones Industrial Average DJIA,
have traded on records. All three benchmarks were positive for the week, with the Nasdaq on the days when interest rates picked up.
The rising yields have resulted in renewed strength for the dollar, which Juckes said he was reluctant to fight at this point. The ICE US Dollar Index DXY,
a measure of the currency against a basket of six major rivals, it was up 0.3% Friday and is up 0.9% so far in March.
“The pattern seems clear enough: the stock market has a sector rotation but no correction; the bond market is rebalancing in light of the much improved economic outlook in both the US and elsewhere; some policymakers have turned against the bond movements, with little success, ”Juckes wrote.
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“As interest rates rise, the dollar rises, but when interest rates reach a new level, the dollar falls back. The pattern is likely to continue until bonds strike a balance, unlikely before 10-year bond yields hit a 2-grip, judging by declining tantrums and past cycles, ”he said.
Societe Generale
Meanwhile, the dollar / Japanese yen is USDJPY,
and euro / Swiss franc EURCHF,
Currency pairs are most sensitive to higher government bond yields (see chart above), Juckes said, noting that dollar / yen typically correlates more closely with real or inflation-adjusted US. yields than nominal interest, while the euro / Swiss franc tends to follow more closely with nominal yields.
Instead, they’ve seen all four – real and nominal yields, dollar / yen and euro / Swissfranc – rise this year, largely in lockstep, he said.
“While US rates are rising, the EUR / CHF and USD / JPY are also likely to continue to trend higher, at least as long as the momentum is strong. If we hit 2% 10-year yields in the coming weeks, a dumb extrapolation could bring USD / JPY to 111 and EUR / CHF to 0.96, ”he said. “Maybe too simplistic, but these moves are too strong to fight in the short term.”