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Bond market uncertainty keeps investors on edge

US markets had their first uniformly negative session of the year so far yesterday, all of the main benchmarks finishing the day lower on the day, on reports that China was reviewing its policy of buying US treasuries.

There were also reports out of Canada that officials there were increasingly concerned that the US will pull out of NAFTA, and while the report was quickly denied by both sides the market reaction suggests that there is rising nervousness about the prospect of increased barriers to trade by the US President.  

The reports out of China in particular made investors nervous, coming as they did on top of the recent adjustment by the Bank of Japan of its bond buying program helped accelerated the selloff in US treasuries, with the US 2 year yield hitting a nine year high, while the 10 year yield pushed up towards 2.6% and the highs seen last year, though they have since slipped back.

While reports like the ones out of China aren’t particularly anything new, it’s been a while since they were last let out for air so to speak. As far back as 2008 there have been concerns that China could use its holdings of US debt as some form of leverage, or as a threat with which to threaten the US, and these threats or concerns have soon passed so it’s hard not to imagine that this time won’t be any different.

After all its not a zero sum game and China would harm itself as much as the US if they went on a buyers strike, and overnight these reports were denied by government sources in Beijing, as SAFE, China’s State Administration for Foreign Exchange saying, to coin a “Trumpism” that they were probably “fake news”.

It is true that China is one of the biggest external holders of US treasuries, along with Japan, which means that they do have enormous influence over how the market can and does move. With concerns starting to rise about a rise in inflation due to the recent strength in oil prices it is understandable that bond markets might be nervous if a normally large buyer of US treasuries either stops buying them or even starts to sell large amounts.

There were similar concerns around 11 months ago when China reduced its holdings of US government debt in 2016 while it was trying to manage capital flight by intervening in the FX markets to support the Renminbi.

In any case China could simply be reviewing its capital allocation strategy for the year, while concerns have been rising about the prospect of trade war between the US and China ahead of a decision later this month by the US Commerce Department about imposing tariffs on some Chinese imports.

Even after all of this it is unlikely that China would take any action to cause a significant ripple in the markets simply because of the scarcity of alternative high quality assets to buy, which means if bond markets are going to continue to fall it is just as likely to be on other concerns like a sharper than expected rise in inflation, which prompts a more aggressive than expected reaction from central banks.

Markets in Europe had a disappointing day yesterday slipping back on profit taking after several days of decent gains, while a similar rally in German 10 year bond yields probably helped push things along, pushing the euro higher back through the 1.2000 level briefly.

The FTSE100 shrugged most of this off managing to kick on to new record highs, helped by a pound that underperformed, despite a strong performance from the manufacturing sector in Q4, which prompted the NIESR to predict GDP growth for the UK economy of 1.8%.

Today’s price action could well be more of the same with particular attention on the bond market as well as the latest minutes from the last European Central Bank policy meeting, where we could well see how big the divisions were with respect to the options discussed with respect to the tapering announcement.

EURUSD – has found support near the 1.1920 area in the past day or so squeezing back to the 1.2020 area in the process. The risk remains to the downside and move towards 1.1600 remains while below the highs of last year at 1.2095.  Above 1.2100 argues for a move towards 1.2170 which is 50% retracement of the 1.3995/1.0340 down move.

GBPUSD – slipped below the 1.3500 area yesterday raising the prospect of a decline back though the 1.3450 level towards support at the 1.3300 area. We need to push through the 1.3660 area to open up a move beyond the 1.3700 area towards the 1.3830 level and February 2016 pre Brexit vote lows.

EURGBP – has found support around the 0.8805/10 area in the past day or so but while below the 0.8925 area and 100 day MA the risk remains towards the downside and the recent range lows at the 0.8740 area, with a close below targeting a move towards 0.8650.

USDJPY – yesterday’s decline through the 112.00 area opens up the prospect of a move towards the 110.80 level and November lows. We need a move back above 112.20 to target a retest of the 113.60 area. A move below 110.70 opens up a move towards 109.80.

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