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London Quick Take - 18 Aug - Global bond rout sends yields to multi-year highs, oil spikes higher as US-Iran ceasefire expires
Neil Wilson
Investor Content Strategist
Note: This is marketing material. This article is not investment advice, capital is at risk.
Bonds are on the move: a sharp rise in government bond yields around the world may start to pose a threat to equity valuations and make life even trickier for deeply indebted nations and policymakers. Volatility in equity markets has however fallen to 2026 lows, picking up again only this week. Stock markets look set up for a corrective move into the Jackson Hole meeting, Labor Day and September's usual seasonal weakness. We often get something around this time of year so I'm not surprised to see the usual August angst play out this way.
US 30-year Treasury yield reached 5.33%, the highest level since 2007. Earlier the 10yr year JGB yield rose to 2.957%, its highest level since 1996. And 30yr UK gilt yields approach 6%. We are seeing bond yields across developed markets strike multi-year highs as fixed income investors grow nervous about a range of factors, from inflation and the Iran conflict to deeper structural concerns and fiscal worries. Issuance is clearly a factor – both on the government side (they can't stop spending!) and on the corporate side (AI capex).
This is also a response to the lack of a clear steer from the Fed since Kevin Warsh took on the role of Chair and dropped all forward guidance for markets – this has been a factor stoking the move up in the long-end of the curve in particular, which has been noticeable since the 29 July FOMC decision ,whilst front end 2yr rates have been a lot more anchored (immediate rate hike expectations fading). With a lack of guidance markets are filling in the blanks to read it dovish because high frequency data (payrolls, CPI) have been a little soft. So, running alongside the comms vacuum is the market pricing out rate hikes next month, dialling back how far they expect the Fed to tighten policy in total, which is feeding into duration risk; ie if the Fed lets it run hot, it runs hot; inflation could get out of control, so investors want protection against that. Note that a new estimate of the medium-run neutral rate by the San Francisco Fed suggests it is around 1.5%...which suggests current monetary policy is accommodative. The move in oil prices has nudged expectations for a Sep hike back up a bit from 30% to around 36%, though this remains well below the 50% implied odds a week ago. I would repeat that the inflation is proving stickier and hotter than a slight cooling in CPI implies. UoM year-ahead inflation expectations ticked up from 4.2% in July to 4.3% this month...repeat that this is a sign that it's going to become incrementally harder for the Fed to re-anchor inflation expectations. If the Fed hikes next month and regain some inflation-busting credibility it may be able to tamp down on this blowout in the long-end and re-anchor expectations.
Of course, it's not just the Fed - issuance matters as the Federal government keeps spending and debt keeps rising (cf France, Britain etc) and crucially we have some added political uncertainty risks as it's the mid-terms - we don't really know what the US political scene will look like come November, adding to the uncertainty. Meanwhile over in Japan, which has been an anchor for global bond markets for years, JGBs are starting to look a little unhinged. Although the GDP print was softer than expected, the inflation deflator was hot, pushing up the yield on Japanese bonds - the assumption that they will need to move more aggressively to counter the correlated problems of higher inflation and a weaker currency, which we know they like to defend around the 160 level. Meanwhile buyers of government bonds are becoming less policy-sensitive and more price-sensitive. We have noted before that the shift to DC from DB schemes and demographic shifts have meant less demand for long-dated gilts, but it seems to be a problem around the globe. 10yr TIPS (inflation protected Treasury yields) are well above the 2% level at which equity returns become weaker and they could sustain this for longer as fiscal risks support term premia. In other words, investors are worries about fiscal risk and inflation combined.
Clearly a significant part of the problem in the very near term is oil and energy prices generally. Brent rose clear of $91 a barrel as the US-Iran ceasefire expired and attacks on ships resumed. Trump threatened Oman...the market is back to worrying about military flare-ups so is baking in some added geopolitical premium to crude. The move has sent Brent futures to the highest since the end of July as traders display renewed angst about just how likely it is the situation can be resolved soon. There are growing concerns also the longer this drags on about the state of crude oil inventories around the world, with the US SPR at a 40-year low, diesel cracks now at records and so on. It's perhaps less about the very near-term impact of oil prices but the broader sense that bond markets need to bake in a world of frequent and persistent supply shocks.
European stock markets fell broadly in early Tuesday, extending the decline yesterday, though firmer oil prices provided some relief to the FTSE 100, which traded flat. Wall Street was also lower as stock investors looked over their shoulder at the rattled bond market and didn't like what they saw. US futures pointed to further losses ahead of the cash equity open on Wall Street - we are looking at the S&P 500 opening down around 7,715 where there is support from the 11 August low.
Higher US Treasury yields and volatility across the bond complex has left the dollar the least ugly sister. DXY has pushed up back from 99.20 to around 99.60 where there is some near-term resistance. Sterling fell on yet more signs of weakness in the UK labour - yesterday's 3-month high could be the top of this cycle. EURUSD failed to make the upside breach of 1.16 stick and is back to 1.1570, while the main story is the yen as JGB yields push higher despite weaker growth data. USDJPY broken topside resistance around 1.59.60 to hit its highest since the intervention took about 4% off the cross.
Payrolls down, vacancies down, wage growth coolest in six years...UK labour market data was once again weak and shows there is no reason for the Bank of England to raise interest rates. The risks are clearly skewed to the downside in terms of the economy more than they are skewed to the upside on the inflation side (more on that tomorrow with the latest CPI, which could tick up from 2.6% in June to as much as 2.9%). Clearly higher energy prices are a worry but the labour market report shows that this is not 2022; wages are not about to spiral due to the pent-up demand and dislocation in the labour market. In fact wage growth cooled to 2.8%, the lowest since October 2020. More in the week ahead here.
US 30-year Treasury yield reached 5.33%, the highest level since 2007. Earlier the 10yr year JGB yield rose to 2.957%, its highest level since 1996. And 30yr UK gilt yields approach 6%. We are seeing bond yields across developed markets strike multi-year highs as fixed income investors grow nervous about a range of factors, from inflation and the Iran conflict to deeper structural concerns and fiscal worries. Issuance is clearly a factor – both on the government side (they can't stop spending!) and on the corporate side (AI capex).
This is also a response to the lack of a clear steer from the Fed since Kevin Warsh took on the role of Chair and dropped all forward guidance for markets – this has been a factor stoking the move up in the long-end of the curve in particular, which has been noticeable since the 29 July FOMC decision ,whilst front end 2yr rates have been a lot more anchored (immediate rate hike expectations fading). With a lack of guidance markets are filling in the blanks to read it dovish because high frequency data (payrolls, CPI) have been a little soft. So, running alongside the comms vacuum is the market pricing out rate hikes next month, dialling back how far they expect the Fed to tighten policy in total, which is feeding into duration risk; ie if the Fed lets it run hot, it runs hot; inflation could get out of control, so investors want protection against that. Note that a new estimate of the medium-run neutral rate by the San Francisco Fed suggests it is around 1.5%...which suggests current monetary policy is accommodative. The move in oil prices has nudged expectations for a Sep hike back up a bit from 30% to around 36%, though this remains well below the 50% implied odds a week ago. I would repeat that the inflation is proving stickier and hotter than a slight cooling in CPI implies. UoM year-ahead inflation expectations ticked up from 4.2% in July to 4.3% this month...repeat that this is a sign that it's going to become incrementally harder for the Fed to re-anchor inflation expectations. If the Fed hikes next month and regain some inflation-busting credibility it may be able to tamp down on this blowout in the long-end and re-anchor expectations.
Of course, it's not just the Fed - issuance matters as the Federal government keeps spending and debt keeps rising (cf France, Britain etc) and crucially we have some added political uncertainty risks as it's the mid-terms - we don't really know what the US political scene will look like come November, adding to the uncertainty. Meanwhile over in Japan, which has been an anchor for global bond markets for years, JGBs are starting to look a little unhinged. Although the GDP print was softer than expected, the inflation deflator was hot, pushing up the yield on Japanese bonds - the assumption that they will need to move more aggressively to counter the correlated problems of higher inflation and a weaker currency, which we know they like to defend around the 160 level. Meanwhile buyers of government bonds are becoming less policy-sensitive and more price-sensitive. We have noted before that the shift to DC from DB schemes and demographic shifts have meant less demand for long-dated gilts, but it seems to be a problem around the globe. 10yr TIPS (inflation protected Treasury yields) are well above the 2% level at which equity returns become weaker and they could sustain this for longer as fiscal risks support term premia. In other words, investors are worries about fiscal risk and inflation combined.
Clearly a significant part of the problem in the very near term is oil and energy prices generally. Brent rose clear of $91 a barrel as the US-Iran ceasefire expired and attacks on ships resumed. Trump threatened Oman...the market is back to worrying about military flare-ups so is baking in some added geopolitical premium to crude. The move has sent Brent futures to the highest since the end of July as traders display renewed angst about just how likely it is the situation can be resolved soon. There are growing concerns also the longer this drags on about the state of crude oil inventories around the world, with the US SPR at a 40-year low, diesel cracks now at records and so on. It's perhaps less about the very near-term impact of oil prices but the broader sense that bond markets need to bake in a world of frequent and persistent supply shocks.
European stock markets fell broadly in early Tuesday, extending the decline yesterday, though firmer oil prices provided some relief to the FTSE 100, which traded flat. Wall Street was also lower as stock investors looked over their shoulder at the rattled bond market and didn't like what they saw. US futures pointed to further losses ahead of the cash equity open on Wall Street - we are looking at the S&P 500 opening down around 7,715 where there is support from the 11 August low.
Higher US Treasury yields and volatility across the bond complex has left the dollar the least ugly sister. DXY has pushed up back from 99.20 to around 99.60 where there is some near-term resistance. Sterling fell on yet more signs of weakness in the UK labour - yesterday's 3-month high could be the top of this cycle. EURUSD failed to make the upside breach of 1.16 stick and is back to 1.1570, while the main story is the yen as JGB yields push higher despite weaker growth data. USDJPY broken topside resistance around 1.59.60 to hit its highest since the intervention took about 4% off the cross.
Payrolls down, vacancies down, wage growth coolest in six years...UK labour market data was once again weak and shows there is no reason for the Bank of England to raise interest rates. The risks are clearly skewed to the downside in terms of the economy more than they are skewed to the upside on the inflation side (more on that tomorrow with the latest CPI, which could tick up from 2.6% in June to as much as 2.9%). Clearly higher energy prices are a worry but the labour market report shows that this is not 2022; wages are not about to spiral due to the pent-up demand and dislocation in the labour market. In fact wage growth cooled to 2.8%, the lowest since October 2020. More in the week ahead here.
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