By Bas van Geffen, CFA Senior Macro Strategist at Rabobank
Global yields are heading towards a 15-year high as inflation concerns remains persistent and signs of economic downturns are still elusive.
The latest push higher was partly driven by the minutes of the July FOMC meeting, which revealed that the Committee members’ opinions are diverging. A large majority of the FOMC still saw upside risks to the inflation outlook, which would require further tightening after July. However, a couple of participants had actually preferred to leave the policy rate on hold. A gradual slowdown in economic activity appeared to be in progress, and that increases the risk of ‘overtightening’. The San Francisco Fed argues that Americans have depleted their excess savings from the pandemic, which has so far helped to prop up consumption throughout the hiking cycle.
So, risks are gradually becoming more two-sided. The FOMC concluded that the data arriving in the coming months would help to gauge the extent to which the disinflationary process was continuing, so the minutes support the data-dependent approach to future decisions that Powell had already outlined at his press conference.
We still believe that the FOMC will decide to skip the September meeting, as the more balanced risks warrant a more gradual pace of policy tightening. However, we still see a further deterioration in the economy thwarting a hike at the subsequent meeting, so we essentially expect the Fed to have reached the end of the hiking cycle. That said, risks to this view are clearly skewed to the upside. If core inflation does not continue on the path of gradual decline, or the economy does not deteriorate as quickly as expected, the Fed may continue tightening in H2.
The Atlanta Fed’s nowcasting model certainly underscores the latter of these two risks. The latest runs of the GDPNow model suggest a strong third quarter. On Tuesday, the model estimate jumped to a growth rate of 5.0% q/q annualized, from 4.1% previously, and including yesterday’s data releases, the GDPNow tracks Q3 growth at 5.8% (even as the St. Louis Fed GDPNow remains stuck below 1%).
The Bank of Japan’s latest policy ‘tweaks’ have also left their mark on global yields. When the BoJ modified its yield curve control to allow 10y JGB yields to trade in a wider band around the 0.00% target, the Bank stressed that this should not be interpreted as policy tightening. However, it de facto has been similar to that, with 10y yields shooting through the previous cap of 0.50% to trade in the 0.60-0.65% range for most of August.
Concerns of a further policy shift are even more apparent in the latest government bond auction, though. The 20-year JGB auction saw very weak demand, as evidenced by a decline in the bid/cover ratio and a much larger tail: the difference between the cut-off price and the average auction price was the highest since 1987, according to Bloomberg. This reluctance to bid for the bond suggests that investors are expecting further policy adjustments, and at least see the current market yields as too low.
Despite the jump in JGB yields, the Bank of Japan hasn’t intervened yet – it has done so twice since it raised the cap on the 10-year yield to 1.00%. Arguably, the central bank is being held back by the sharp depreciation of the JPY: keeping rates artificially low as the expectations of Fed hikes gain new ground would obviously not provide the currency with solid footing to stem a slide. Concerns about the JPY were evident after BoJ Governor Ueda acknowledged that the yen’s weakness was one reason to widen the bandwidth of the yield curve control policy – intervening now would undermine these efforts.
Either way, the rising Japanese yields are also bad news for foreign bond markets, which have enjoyed the presence of Japanese bidders looking for a yield pickup. That dynamic could reverse if domestic yields are on their way up.
With Japan reluctantly joining the world of higher rates, China remains the last holdout as the domestic economy continues to struggle. And the bad news from China keeps piling up. First of all, Bloomberg reports that the crisis in the housing market is much worse than the official data had shown so far. Property agents are reporting house price declines that are a multiple of the price declines reported in official statistics. Secondly, Reuters reports that trust firm Zhongzhi, which has large exposures to the real estate sector, is facing a liquidity crisis and will attempt to restructure its debt. This is adding to the concerns that the housing market woes could spread into the broader financial system.
As the trouble piles up, and data continues to point to weak domestic growth, pressure on policymakers to stem the tide is growing. The State Council pledged to support the private sector and boost domestic consumption, and particularly spending on big ticket items. The policymakers did not detail how they would accomplish this though, adding to market speculation that the government will not resort to extensive stimulus policies.
These economic woes and the increasing divergence in Chinese and US rates continue to wither away at the renminbi. The CNY has slid to its weakest level in years, despite intervention by China’s state banks. Reuters reports that the banks are trying to slow the pace of depreciation.
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