A reported trade “truce” between China and US has prompted excited talk of fresh record highs in US stocks, a surge in Chinese stocks, a jump in offshore yuan relative to the dollar, but barely anything in bonds (with 10Y Yields hovering just above 2.00%, unable to hold the overnight spike).
But, as Bloomberg’s Garfield Reynolds warns, the key danger across markets is the potential for a corrective yield spike that would pummel risk assets and worry investors that they have fallen for a low-yield trap.
Falling bond yields have been the big surprise of 2019 so far and there’s an excellent chance they will grind lower in the second half — and take stocks with them — as weak growth spurs global monetary easing.
Given how tough it has been to forecast bond yields, getting that call right for the rest of the year is key.
A reminder of how difficult that can be comes from San Francisco Fed President Mary Daly. Twice last week she said it’s very hard to say what the central bank should do, including comments that she’s unsure “whether interest rates will be lower a year from now.”
Surveying the outlooks our team came up with at the start of 2019, it’s clear our biggest misses were all in bonds
The same goes for those readers who took part in our surveys. Treasury yields finished June more than 100 bps below the consensus for end-2019, while bunds were ~75 bps lower and Italian yields a whopping 105. Bond analysts were also far too bearish.
What some forecasters may find especially galling is the way the yield projections actually look sensible if you consider where equity gauges are now. The same goes for FX projections that mostly favored a soft-dollar outlook.
Our readers were bearish bonds and bullish equities, and while equities are mostly well north of the WHIS numbers, bond yields are way, way south.
Oddly enough, the growing concern right now seems to be the rush into bonds has created massive duration risk that could set off a global version of the so-called VaR shock that hit Japanese government debt back in 2003.
Very few seem to be raising concerns that U.S. equities at a record high would be at least as exposed to the turmoil that would come. Consider how the spike in Treasury yields in February 2018 set off global carnage for stocks.
Still, with central banks marching down the easing path, justified by a record stretch of data disappointment, a meaningful backup in yields looks unlikely.
The G-20 trade truce did very little to indicate a resolution to the U.S.-China conflict is imminent, so that will continue to weigh on the global growth outlook.
The key question is whether yields that stay at current lows or drop further can go on being fuel for equity rallies?
Your answer to that may come down to whether you buy into the “insurance cut” thesis that the Fed will be able to preserve the U.S. economic expansion with a rate move or two.
What looks more likely is that equities ultimately succumb to the macro logic that has fueled this year’s bond rally.