This article is written by CMC APAC market analysts; Kelvin Wong, Tina Teng and Leon Li
In the past 4 weeks, the key benchmark US 10-year Treasury yield has inched up significantly as it continues to evolve within its 2-year major uptrend phase in place since March 2020.
It has surged by almost 220 basis points from its all-time low of 0.33% printed on 9 March 2020 and to an intraday high of 2.55% on 28 March 2022. An important point to note that this recent spiked up has not been accompanied on a growth resurgence backdrop; circa December 2020 to March 2021 where the global economy has started to reopen on a piecemeal basis from Covid-19 restrictions and the initial rollout of vaccination programmes that benefited cyclical related stocks but rather on a backdrop of heightened global inflationary pressures.
The US Federal Reserve, the Fed and majority of the developed nations’ central banks have concluded that the surge in global inflation rates in the past one year are not transitory but rather persistent in nature where the Fed has started to provide more hawkish guidance since late December last year. It has kickstarted its interest rate hike cycle in March and soon details of its quantitative tightening programme that is likely to be announced in May. All in all, the Fed’s current primary objective and guidance has taken on a path of containing inflationary pressures from creeping higher rather than enacting pro-growth policies that are beneficial to risk assets.
Hence, the recent up move seen in US 10-year Treasury yield since the start of 2022 is more geared towards an expected increase in the pace of monetary tightening policies which in turn can trigger higher borrowing costs across the spectrum; from short to longer term tenures. Given such a scenario, it is likely to see a slowdown in economic growth in the next three to six months via a tightening of global liquidity conditions and certain portions of the US Treasury yield curve have started to invert; pre-signals for a recession.
2.55% is the major level to watch on the US 10-year Treasury yieldSource: TradingView (click to enlarge chart)
From a technical analysis perspective, 2.55% is a major resistance to watch on the US 10-year Treasury yield and a clear bullish breakout above 2.55% sees a potential end to its 40-year plus of long-term secular downtrend with a further potential surge to the next major resistances at 4% and 5.20% which translates to an end of a 40-year bull run for the global bond market.
Implications of a bullish breakout above 2.55%Source: TradingView (click to enlarge chart)
Companies that utilised more leverage to drive revenue and profit growth targets such as small-caps equities that are represented by the Russell 2000 benchmark index is likely to see further potential underperformance against the general market, S&P 500.
Even the bulls of the S&P 500 may not be able to escape the wrath of a rapid increase in the US 10-year Treasury yield. US liquidity conditions as indicated by the Chicago Fed National Financial Conditions Index (NFCI) are getting tighter as it has risen by +57% from June 2021 (see chart above).
Interestingly, a similar increase in magnitude can been seen during January 2007 to August 2007 on the NFCI, just before the S&P 500 peaked in October 2007 and kickstarted its previous secular bear market triggered by the US subprime housing crisis that led to a decline of -50% from October 2007 to February 2009.
Next up on the macro radar will the recent rapid speed of JPY depreciation. Since the start of the year, the JPY is the weakest currency among its developed nation’s peers as it shed by -6% against the USD due to divergence of monetary policies between Bank of Japan (BoJ) and the US Federal Reserve.
BoJ has continued to maintain its ultra-easing monetary policy staunchly and chose to defend its “Yield Curve Control” programme enacted in 2016 where it will not allow the 10-year Japanese government bond (JGB) yield to deviate away from an upper limit of +0.25% and a lower limit of -0.25%. In the month of March, global sovereign bond yields have been on a tear to the upside which in turn put upward pressure on the 10-year JGB yield that forced the BoJ to step in and pledged to buy unlimited amount of JGBs during the last week of March to defend the +0.25% ceiling after the 10-year JBG yield hit a high of 0.27% on 28 March.
Overall, the actions undertaken by BoJ have indicated that the odds are slim for a normalisation from its current loose monetary policies and in turn, the yield premium of the US 10-year Treasury over 10-year JGB is likely to increase over the medium-term horizon. Hence, the further potential JPY weakness is expected in Q2 which may see a continuation of the up move in the USD/JPY exchange rate.Source: TradingView (click to enlarge chart)
From a technical analysis perspective, the odds are skewed in the favour that the USD/JPY has kickstarted a major uptrend phase after the recent bullish breakout from its former long-term secular descending resistance that has capped previous rallies since April 1990. The next major resistances to watch are at 147.60/149.30 and 159.30/161.15 with key long-term pivotal support at 114.50 to maintain the bullish bias.
Implications of further significant JPY weakness
Given that the odds of a global recession have increased as per highlighted earlier, a rapid depreciation of the JPY against the USD may cause several Asian economies’ currencies that rely on exports to drive growth such as South Korean Won and Taiwan Dollar to weaken in the coming months to maintain their respective exports’ competitiveness which in turn put pressure on China’s exports growth.
Thus, the China’s yuan now has another factor (a weakening JPY) on top of shrinking fixed income yield advantages and narrowing trade surplus that can add onto its depreciation pressure after it has booked two years of significant gains against the USD.
It seems to be a déjà vu moment now, in the prior months that led to the “shock” yuan devaluation engineered by the People’s Bank of China (PBOC) on 11 August 2015, the JPY had depreciated in a similar magnitude against the USD and offshore yuan (CNH). Right now, the CNH has strengthened against the JPY by around 130 pips since the start of the year and the CNH/JPY exchange rate is now approaching a major peak of 20.20 formed in June 2015 before the yuan devalued three times against the USD in August 2015 (see chart below).
CNH/JPY is approaching a major peak, decreases China’s export competitivenessSource: TradingView (click to enlarge chart)
Given the current weak global economic climate and recent Covid-19 lockdowns in China that are likely to dampen economic growth in Q2, PBOC is now facing a dilemma whether to keep the yuan at its current strong level which can put a cap on imported inflation but at the expense of growth; lesser exports and indirect tighter financial conditions that goes against PBOC’s current guidance of targeted easing monetary policy to maintain economic stability and to achieve an annual targeted GDP growth of around 5.5% for 2022.
The odds seem to be in the favour of a yuan depreciation in Q2 if history repeats itself; the aftermath of the August 2015 episode triggered a risk off event that saw global equities declined by around -15% in the next six months.
Next up, we will discuss and explore further the impact of these two key emerging macro factors on the US equity sectors and China stock market respectively.
Click here to read Part 2 of Q2 2022 global markets emerging themes
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