Bond yields, crude oil markets continue to rally

The main focus of financial markets over the past few sessions has been on the sharp move higher in developed market bond yields. Looking at US yields first; 5-year yields are probing the April high at 0.99% ahead of a test of the key 1.0% level that 5-year yields haven’t been above since February 2020. Meanwhile, 10-year yields are probing the 1.50% mark and 30-year yields are above the key 2.0% level. With key levels having been broken to the upside for these longer-term yields (10-year yields having surged well above the 1.38% level that had acted as strong resistance throughout August and most of September), some bond technicians are calling for a move back to test annual highs, which in the case of 10-year yields is in the upper 1.70s% and for 30-year yields is around 2.50%. As noted, the yield rally is not just local to the US but is also being seen in other markets; German 10-year has now surged above -0.2% and are only about 10bps below annual highs just above -0.1%, while UK 10-year yields breached the psychological 1.0% level for the first time since March 2020. Yields have been boosted in recent days primarily by the hawkish undertones sent by the FOMC and BoE at their policy meetings last week, both of which at the time resulted in money markets bringing forward their expectations for rate hikes (money markets are now betting on a Q1 2022 15bps rate hike from the BoE and a strong likelihood of a 25bps hike from the Fed in September 2022).

A rise in inflation-adjusted yields is certainly contributing to the yield rally in the US, but this has not been the case in Europe; indeed, while nominal 10-year German and UK yields are up roughly 15bps and 20bps respectively over the past few days, inflation-linked 10-year yields in the respective countries are little changed, implying a jump in inflation expectations. This could reflect concern about the inflationary impact of the sharp rise in European energy prices in recent months; since February, European natural gas prices have nearly quadrupled from under EUR 20 per megawatt-hour to above EUR 70). Certainly, this is not the kind of inflation central bankers want to see. The energy price surge has since spread elsewhere – China is now in the midst of a touted “power crunch” which has led to authorities ordering factories to halt activity to preserve power for homes. As major gas exports Russia and US (who also face a domestic supply crunch) mull limiting exports to preserve domestic stocks, the situation is expected to get worse before its better. Tightness in natural gas markets is spilling over to higher prices in the markets for other fossil fuels such as coal and oil, as energy utility providers increasingly look for substitutes. Much attention has been made of the fact that Brent managed to poke its head above the $80 level today for the first time since 2018 and WTI is also looking buoyant above $76.00 per barrel as it looks to challenge annual highs of just under $77.00. Panic fuel buying in the UK amid fears of a petrol shortage is also likely supporting prices – there won’t be a petrol shortage in the UK, but there is a slight shortage of HGV drivers to get the petrol to the pumps – this is what the UK media initially pounced, stoking the panic.

Whatever is causing the rise in global developed market bond yields, the impact on equity markets seems to be broadly negative; S&P 500 futures have slipped under the 50DMA again in early trade weighed by losses in “growth” stocks (hence why tech-heavy Nasdaq 100 futures are underperforming this morning), whilst “value” stocks are performing better (hence why Dow futures are holding up a little better). S&P 500 futures are currently testing the psychologically important 4400 level, down about 0.9% so far on the session. Equity bulls will be disappointed that the rally from last week’s near-4300 lows already seem to have lost momentum, rather than continuing on to challenge record highs in the 4550 regions. “Buy the dip” appetite seems to have weakened and 50DMA seems to have finally lost its magic – before the start of last week, buying at the 50DMA and holding for fresh record highs had been a highly profitable strategy. Higher yields and the prospect of a more hawkish Fed certainly do seem to weigh on the desirability of stocks at these levels. Let’s see if higher energy prices can save the day (a surge in crude prices can help equities), but if surging energy prices trigger further central bank concerns about persistently higher inflation that leads to further hawkish shifts, this is unlikely to be a net positive. Looking at other markets; European equities are also in the red with the Stoxx 600 down sharply by about 1.6% and now only a couple of points above last week’s 450 lows. The tone in last night’s Asia Pacific session was also broadly downbeat aside from Chinese equities (the Shanghai Comp ended up more than 1.0%) which were boosted by more PBoC liquidity injections.

Looking now at FX markets; it’s a bit of a mixed picture given that FX markets are being driven by a slightly unusual combination of risk-off (stocks substantially lower), higher yields, higher energy prices, but lower metal prices. The main thing to note is that the US dollar is stronger and the DXY has managed to push above last week’s post-hawkish-FOMC highs around 93.50 to the 93.60s, as it benefits from a rise in US vs G10 rival real yield spreads as well as safe-haven flows with stocks selling off. Indeed, it seems that the dollar is the haven of choice today, as the rise in US/Japan rate differentials has undermined the appeal of the yen (USDJPY is highly sensitive to the US/Japan 10-year yield difference, rallying as it widens and vice-versa). The yen is currently down about 0.4% on the day, putting it level with the struggling (due to its sensitivity to risk and metal prices) Aussie. But these are not the worst G10 performers; GBP is down about 0.6% and NZD down closer to 0.7%, despite a notable lack of domestic drivers in either country (although in the UK there continues to be a lot of focus on the “fuel crisis”). The currencies holding up better versus the buck, which is the best performer in the G10 this morning, are the euro and Loonie (the latter getting support from surging crude oil prices) and the safe-haven and slightly less rate differential sensitive Swiss franc.

Note that there has already been a bombardment of central bank speak this week from Fed, BoE and ECB members. Starting with the former; as is customary, Fed Chair Powell’s pre-prepared remarks which he will deliver in person at his testimony before the Senate Banking Committee today were released to the public last night and did not contain anything that he hasn’t already said at the post-FOMC meeting press conference last week, may have placed a bit more emphasis on the risk that inflationary pressures last longer than the bank is currently expecting. Williams pretty much echoed Powell’s remarks last week word for word (QE tapering could come “soon”, i.e. by the end of the year, and the taper could finish in mid-2022, but rate hikes till a long way off). Brainard sounded a little more dovish as is customary for her but seemed to endorse the current guidance on what the QE taper timeline is likely to look like. Elsewhere, ECB President Lagarde highlighted the risk of further upward revisions to the bank’s inflation forecasts ahead of the release of the preliminary estimate of Eurozone inflation on Friday, though stuck by her view that inflation would thereafter quickly slide back under 2.0%, meaning it remains appropriate for the bank to continue with its ultra-accommodative monetary stance. Finally, BoE Governor Bailey reiterated the tone of last week’s hawkish BoE statement on monetary policy, saying that he and other MPC members see a growing case for interest rates hikes.

The bombardment of G10 central bank speak is far from over; today sees the start of the ECB’s two-day online Sintra forum, which will see various ECB governing council members speaking (including Lagarde) and will culminate in a panel discussion tomorrow that will include Fed Chair Powell and BoE Governor Bailey. But we hear from Powell before that, at his testimony before Congress today (from 1500BST) – as noted, the pre-prepared remarks have already been released but the Q&A is worth watching. There will also be other FOMC members on the wires, including Evans at 1400BST, Bowman at 1840BST and Bostic at 2000BST. Aside from all the central bank speak, FX (and broader markets) will be watching the release of the September US Conference Board Consumer Confidence survey at 1500BST.