Stocks Sputter as US 10-Year Yields Test 3% Amid Commodity-Led Inflation Spike

Stock SectorApril 23, 20187min12

Global bond markets resumed their bearish tact Monday, taking benchmark 10-year Treasury notes closer to 3% for the first time in more than four years and threatens the strength of the current equity market really as it heads into the teeth of the U.S. corporate earnings season.

Benchmark 10-year notes traded as high as 2.99% in early European dealing while the dollar index, a measure of the greenback against a basket of six global currencies, to a near one-month high of 90.43. In fact, the current gap between 10-year government bond yields between the United States and Germany, the biggest economy in Europe, hit the highest level in 29 years Monday — 2.36% — as some of the global appetite for Treasuries waned amid concern over the fiscal indiscipline of the Republican-led Congress, which passed a $1.5 trillion tax cut late last year that has added notable pressures to the country’s deficit.

“The higher US yields are a pretty severe short-term headwind for equities globally as it tightens financial conditions and sweetens alternatives,” said Saxo Bank’s head of equity strategy Peter Garnry.

Direction of the #EURUSD: Keep an eye on the spread between the yield curves.

— Ole S Hansen (@Ole_S_Hansen) April 23, 2018

Treasury yields have risen sharply in the past two weeks as global oil prices spike in the face of renewed speculation that Saudi Arabia will use its influence in OPEC to keep supplies tight as it preps the partial float of is state-owed oil company Aramco earl next year. The resultant rise, as well as that in metals prices, which surged in the face of both U.S.-led sanctions on Russia and President Donald Trump’s twin tariffs on steel and aluminium imports, has stoked concern that inflation will begin to accelerate in the coming months.

The U.S. Federal Reserve’s signalling on future interest rate hikes is also supporting rising yields, with  San Francisco Federal Reserve Bank President John Williams saying last week that he expects to see domestic consumer prices staying above the central bank’s 2% objective for “another couple of years”.

“The recent rise in US Treasury yields looks to have been a function of rising inflation expectations, where presumably the Russian sanctions-related surge in metal prices has played a part,” wrote ING strategist Chris Turner. “San Francisco Fed bank president John Williams also made some pretty candid comments on Friday that the Treasury curve would re-steepen from the long end as the Fed shrinks its balance sheet and the US government issues more debt to fund stimulus.”

US 10y bond yield inching close to 3%, #DXY near key resistance levels. After a few months of boring sideways range trading, we could be on the cusp of a breakout with the #USD putting on a near-term technical rebound given the extent of short positioning.

— Khoon Goh (@Khoon_Goh) April 23, 2018

Rising bond yields are problematic for global equity markets in that they offer alternatives for fund managers looking to allocate cash and improve performance. So far this year, the S&P 500 has generated a total return of -0.13%, while its overall dividend yield sat at just 1.87% at the end of March. Risk-free 2-year Treasury bonds, by contrast, offer a yield to maturity of 2.47% 

The region-wide Stoxx Europe 600 slipped 0.14% in the opening 30 minutes of trading, with major benchmarks in Europe falling around 0.5% as crude continues to hold past three year highs following last week’s meeting of OPEC officials in Jeddah.  Futures contracts tied to the Dow Jones Industrial Average were marked 47 points lower from Friday’s 24,462.94 close while those tied to the broader S&P 500 were also seen 0.2%, or 3.25 points, lower in early Monday trading

That said, Bank of America Merrill Lynch’s latest ‘Flow Show’ report week noted that $3.3 billion in new equity allocations supported equity markets last week and outpaced the $2.8 billion into bond markets. 

Higher borrowing costs also slow corporate investment and personal spending, two key drivers of U.S. economic growth, putting further pressure on future earnings generation and blunting the value of domestic stock markets. 

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