Originally published by IG Markets
The global bond rout carried through the overnight session, though it must be said the selling pressure eased through-out the evening.
Bond-rout spreads: The price action centred around a lot of catch-up in other sovereign bond markets, as traders realigned their positions to reflect the ongoing dynamic in US Treasuries. Yields on 10-year German Bunds were up around 5 points for the session, and 10-year Gilts added over 9 points; while the BOJ (during Asian trade) signalled their comfort with slightly higher yields in the face of a weaker Yen, with 10-year JGB yields floating to 0.15 per cent. The yield on benchmark 10-year US Treasury burst through 3.20 per cent in early North American trade, before better sense prevailed and settled the yield slightly above the opening price of 3.18 per cent.
A Fed led sell-off: The prevailing view remains that this marked shift in bond prices reflects markets playing catch up with the US Fed's view on the US economy. The most considerable uptick in yields came on the back of US Jerome Powell's speech yesterday morning (AEST), after the Fed Chair maintained his very optimistic line that the US economy is in an extraordinary position. Based on this and the activity over the last 24 hours, bond markets in principle have further to fall: interest rate markets haven't priced in anywhere near the full gamut of forecast rate hikes from the Fed. The relationship means that there is plenty room for greater volatility, the risks of which could see a protracted shake-up across asset classes.
Non-Farm Payrolls: Considering the aggressiveness of price movements in the last day-or-so, tonight's Non-Farm Pay rolls takes-on even greater gravity. The US economy is nominally at full employment, so the interest will be directed to wage growth figures once more, as the missing ingredient of the US growth/inflation model. Last month's release showed a better than expected lift in wage growth, finally indicating tighter capacity in the US economy is flowing through to wages. It's apparently so that fixed income and currency markets have implicitly priced-in a bumper set of figures tonight, on the basis that recent data has represented a red-hot economy. Though it's a contrarian play, an underwhelming set of figures could prompt a snap-back in bond markets tonight, given sentiment has moved so far in the one direction.
US inflation: Prospects of inflation risk in the US have been raised but largely brushed-off or ignored by market participants, despite the risk of an overheating economy. It's a phenomenon even the Fed has hosed down, suggesting that inflation is within the realms of control - justifiably so it seems, when looking at the data and pricing in markets. It's a risk worth mulling however, especially as it applies to the sustained rise of oil prices, which looks set to continue as supply and production problems bite, along with the possible impacts of higher global tariffs. These variables exist outside of central bankers control, but hints that wages growth may be picking up in an overheating economy will introduce complexity to the Fed's already fraught tightening path.
ASX and global equities: It's these sorts of concerns that have investors nervous about the times ahead. SPI futures are indicating a 0.50 per cent drop at the open for the ASX 200, following the dour-lead delivered by Wall Street and European indices, which shed in the range of 0.75 to 1.5 per cent, depending on the chosen geography and/or index. The Australian share market benefitted from the tick up in global bond yields yesterday, courtesy of the prospect that higher global rates would boost bank profitability. The rally in the financial sector carried the index back within its recent trading range, to close the day's session at 6176. The ASX 200 is poised to join the sell-off in global equity markets today however, as fears filter through that higher global rates will lead to a diverting investment towards less risky fixed income markets; a stretching of equity valuations from higher discount rates; as well as a general drag on corporate profits from lower consumption and economic activity.
Australian dollar and Retail Sales: Looking closer to home, the Australian session will be highlighted by domestic Retail Sales data. Though not expected to shift financial markets too greatly, today's results will potentially place further pressure on the embattled Australian dollar. Despite the US dollar retracing against most other major currencies last night, the Aussie currency remained under pressure, currently trading below support/resistance around 0.7100. The yield play must be the predominant driver behind this, as the spread on the US 2 Year Treasury and Australian 2 Year Commonwealth Government blows out to near-90 points. The AUD/USD's putative descent to below 0.7000 seems more imminent by the day, with today's Retail Sales data presenting as another possible nail in the coffin.
Next week: Turning focus to a summary of what lies ahead next week: the biggest risk to local markets must be the return of China’s to the global stage, following this week’s week-long holiday. The absence of Chinese activity in markets has allowed for a welcomed silence on the trade war and the consequent volatility that has followed in equity indices and currencies. The offshore-yuan will be an asset to watch next week, which with the PBOC on the sidelines, has been pushed by traders to the very significant price of 6.90. The other news release that will be of international importance, particularly given this week’s volatility in bond markets, will be US inflation data on Thursday, which will be examined (as explored earlier) through the lens of how a hot US economy and rising global input costs may be impacting consumer prices.