The US 2-year Treasury Yield Reached The Highest Since 2007!

The US 2-year Treasury Yield Reached The Highest Since 2007!

Summary:  Equity markets plunged on Friday in the wake of Fed Chair Powell’s speech, in which he invoked famed Fed inflation fighter Volcker and warned against a premature easing of policy. While US yields are only modestly higher in the wake of the speech, the US dollar is soaring, bringing a new unwelcome tightening on global liquidity. Particularly intense focus on USDJPY as the Bank of Japan faces a new challenge from JPY weakness as it insists on maintaining its maximum easing policy.


 

What is our trading focus?

Nasdaq 100 (USNAS100.I) and S&P 500 (US500.I)

US equities posted their worst session since at least June in the wake of Fed Chair Powell’s Jackson Hole speech on Friday, with the S&P 500 losing over 3% on the session and trading lower still overnight to start the week, with the psychologically key 4,000 level looming into view. The Nasdaq sliced over 4% lower and traded near its 55-day moving average overnight, in the 12,400 area. Sentiment looks fragile, with any further rise in treasury yields and the US dollar the key risk for driving a possible worsening of sentiment this week.

Hong Kong’s Hang Seng (HSIQ2) and China’s CSI300 (03188:xhkg)

After having staged an impressive bounce from the trough of a 2-month losing streak last week on the back of reports that the U.S. and China regulators were reaching a deal to avoid the delisting of Chinese companies from U.S. bourses, Hang Seng Index fell nearly 1% on Monday following the post-Jackson Hole selloff in U.S. equities. In addition, in statements from the U.S. and China regulators last Friday regarding access to audit work papers, the interpretations looked rather different in some key aspects. According to the Public Company Accounting Oversight Board (PCAOB), the agreement gives the U.S. regulator, “complete access to the audit work papers, audit personnel, and other information”. On the other hand, in its announcement and Q&As with reporters, China Securities Regulatory Commission emphasized that audit work papers and other information will be “obtained by and transferred through Chinese regulators”. Meituan (03690:xhkg) outperformed, +3.7% after reporting a solid Q2 and continuous order growth in June and August. CSI 300 dropped 0.7%. 

US dollar and especially USDCNH in the wake of Fed Chair Powell’s speech

A forceful new USD rally was set in motion in reaction to Fed Chair Powell’s speech on Friday, with more aggravated strength versus Asian currencies on Monday as yields rose and the JPY weakened (more on USDJPY below), but also as China allowed its currency to drop versus the US dollar, a key development in cementing the impact of this USD move globally. The most salient potential driver for further USD strength this week would be strong US data (especially on Friday’s August US jobs and earnings report) that drives Treasury yields higher.

USDJPY

While the focus is generally on the US dollar this week already and the broader fallout should the greenback continue its aggravated ascent, the stakes are very high for USDJPY, which risks a new upward spiral that will challenge the Kuroda-led Bank of Japan as it insists on maintaining it accommodative policy in the face of rising yields elsewhere.  A massive bout of volatility may lie ahead if market participants decide to take on the BoJ, which will eventually likely cave at some unknown level higher, perhaps 150 in USDJPY if it rises that far?

Crude oil prices (CLV2 & LCOV2)

Crude oil trades higher extending last week’s gain with supply concerns more than offsetting the potential negative growth/demand impact of Powell’s higher-for-longer interest rate speech on Friday at Jackson Hole. An Iran nuclear deal has yet to be reached with a breakthrough unlikely to add much in terms of additional barrels before next year. Libya, one of OPEC’s most volatile producers saw deadly clashes in the capital over the weekend sparking fears over supply to an energy starved Europe. In a addition high gas prices in Europe and Asia will continue to underpin demand and prices for diesel and heating oil. Brent is currently stuck in a range around $100 with resistance around $103 and support at $98.

Gold (XAUUSD), silver (XAGUSD), platinum (XPTUSD) and copper (COPPERUSDED22)

... have tumbled the most since Friday after Fed’s Powell signaled that interest rates would keep rising and remain elevated for longer. The US 2-year Treasury yield reached the highest since 2007 with additional headwinds seen from the stronger dollar. The markets belief in the Fed’s ability to combat inflation helped drive the one-year inflation swap down to 3.06%, a one-year low. We maintain the view of gold being a hedge against the belief the Fed will be successful in lowering inflation without hurting economic growth to the point where the focus returns to central bank support but given the renewed breakdown on Friday and continuation today, the price may in the short term once again look at critical support below $1700.

US Treasuries (TLT, IEF)

US treasury yields rose across the board on Friday, actually quite modestly relative to the attention given to Fed Chair Powell’s speech, but the move followed through further in the Asian session Monday as the US dollar also rose, a toxic combination for risk sentiment. The US 10-year benchmark yields trades near the highs last week above 3.10% this morning, with the chief focus on the 3.50% area high established in mid-June if yields continue to rise. This week features important US data through Friday’s US jobs report.

What is going on?

Powell’s message at Jackson Hole gets serious

While Powell still stayed away from clearly defining a rate path or the expected terminal rates for the Fed, his strong message did suggest that the fight against inflation is far from over. Powell reiterated that the decision on September 21st on whether the Fed will lift rates by 50bps or 75bps will be driven by the “totality” of data since the July meeting. That puts a great deal of emphasis on the US jobs report due on September 2nd, and the US CPI report due September 13th. There was also some emphasis on rates being held at the peak rate for some time, but there isn’t a substantial change to the market’s expectation of the Fed path yet, with cuts still seen for next year by the money markets.

Other Fed speakers still see higher terminal rates

Inflation remains the overarching theme in all the Fed talk, and no comfort is being taken from the softening in July inflation. Mester (2022 voter) accepted that the Fed hasn’t reached neutral rates yet and said that rates need to go above 4% and held there for some time. Bostic (2024 voter) also suggested a higher terminal rate of 3.5-4.75% compared to what was reflected in the June dot plot, and said rates need to be held there for some time and rate cut talks are premature.

Soft US July PCE inflation confirms the dip in the CPI data

Lower petrol prices cooled price pressures in July, and this has been re-confirmed by the PCE print on Friday. The headline came in at 6.3% YoY (vs. 6.8% expected) while core was at 4.6% YoY (vs. 4.7% expected). The market reaction to these softer numbers was however restrained as the hawkish message from Powell at Jackson Hole took the limelight. The magnitude of the September rate hike still remains a coinflip, but the Fed members have refused to take comfort with the softer CPI print and continue to push for an aggressive fight against inflation.

ECB speakers remain committed to inflation fight despite recession risks

A host of ECB speakers at the weekend continued to push for aggressive rate hikes to fight inflation. Schnabel, speaking at Jackson Hole, said rates must be raised, even into a recession. Kazaks also emphasised the need for further front-loading of rate hikes after the 50bps rate hike announced by the central bank in July. In fact, there were hints of a 75bps rate hike. There were also some concerns on a weaker EUR, as that fuels further inflationary pressures and the benefit of cheaper exports is diminished by supply chain disruption. Villeroy said that the neutral rate should be reached before the end of the year while Kazaks said he would get there in the first quarter of next year.

Energy prices continue to climb in France

Last Friday, the French 1-year electricity forward was close to €1,000 per MWh (versus €900 per MWh for Germany). This represents an increase of +1000 % compared with the long-term average of 2010-2020. Since Autumn 2021, the French government has capped electricity and gas prices (electricity price increase was capped at +4 % this year). But this is very costly for public finances (about €20bn so far this year). The cap on energy prices will expire at the end of the year for gas and in February 2023 for electricity. The government is not planning to extend it further. More targeted measures to help the poorest part of the population to cope with higher energy prices is the most likely scenario. The risk of electricity shortage is real in France this winter. During the summer, electricity demand is around 45 GWh. During the winter, higher consumption will push electricity demand around 80-90 GWh. This will put under tension all the electricity infrastructure, thus increasing the risk of shortage. We think that France is certainly in a worse position than Germany when it comes to energy supply (in the short-term).

The world's fourth largest iron ore miner, Fortescue releases 2nd highest profit on record

Fortuecue Metals (FMG) posted a 40% drop in full-year profits, mirroring the steep declines in iron ore prices. Despite iron ore shipments hitting a record, Fortescue posted a A$6.2 billion profit, down from the A$10.35 billion last year. So what’s next? It’s pledged another record year of iron ore shipments (187-192mt) and wants to accelerate its push into clean energy, aiming to produce an initial 15 million tons a year of green hydrogen by 2030, to help its heavy industry and long-distance transport decarbonize. It will spend $600-$700 million to do so this financial year. As we covered last week in our BHP interview, iron ore demand is likely to slow over the coming 30 years (that’s where Fortescue’s income comes from). Meanwhile, the world requires double the amount of green metals. So the question remains; can Fortescue diversify its business in time? Fortescue’s shares are up 21% from their July low, with investors hoping China infrastructure stimulus will support iron ore demand and boost the company’s earnings. 

What are we watching next?

The US dollar is the wrecking ball here for risk sentiment – any rise in US yields would make things worse

The rising US dollar is bad enough for global markets as the greenback is a financial condition unto itself, but if US treasury yields continue to rise this week, this could prove double trouble for global markets and potentially aggravate the sudden downside momentum tilt set in motion on Friday by Fed Chair Powell’s speech at the Jackson Hole conference.

 

China manufacturing PMIs, scheduled to release this week, are expected to decelerate in the midst of power curbs

The median forecasts of economists surveyed by Bloomberg expect China’s official NBS manufacturing PMI to edge up to 49.3 in August from 49.0 in July but remains firmly in the contractionary territory and the Caixin manufacturing PMI to slide to 50.1 in August from 50.4 in July, approaching the threshold between expansion and contraction. The heatwaves and drought-induced power curbs caused Sichuan and Chongqing to shut-down manufacturing activities for six days and eight days in August, respectively. The median forecast for the August official NBS non-manufacturing PMI is 52.2, down from last month’s 53.8 but remains in the expansionary territory. 

Earnings to watch

This week’s earnings will tilt towards a Chinese focus, but from a macro perspective we are watching Lululemon on Thursday to get an update on the US consumer. Expectations are still looking for a +20% y/y revenue growth in the current quarter so the bar is set high on the outlook.

  • Monday: Haier Smart Home, Foshan Haitian Flavouring, Agricultural Bank of China, BYD, Pinduoduo, Trip.com, DiDi Global, CITIC Securities
  • Tuesday: Woodside Energy, ICBC, China Yangtze Power, Muyuan Foods, SF Holdings, Shaanxi Coal, Midea Group, Tianqi Lithium, Ganfeng Lithium, Bank of Montreal, China Construction Bank, Bank of China, Great Wall Motor, COSCO Shipping, Partners Group, Baidu, Crowdstrike, HP
  • Wednesday: MongoDB, Brown-Forman, Veeva Systems
  • Thursday: Pernod Ricard, Broadcom, Lululemon Athletica, Hormel Foods
  • Friday: BNP Paribas Fortis

Economic calendar highlights for today (times GMT)

  • 0800 – Switzerland SNB Weekly Sight Deposits
  • 1300 – ECB Chief Economist Lane to speak
  • 1430 – US Aug. Dallas Fed Manufacturing survey
  • 1815 – US Fed Vice Chair Brainard to speak
  • 2330 – Japan Jul. Jobless Rate
  • 0130 – Australia Jul. Building Approvals

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Source: Financial Markets Today: Quick Take – August 29, 2022