The most impactful market changes these days would no doubt be the surge of long-tenor sovereign yield. Although the market pays heavy attention to the U.S., most other non-U.S. sovereigns have experienced a similar sharp surge: Over the past two quarters (from end Q1 to end Q3), U.S., Canada, and Australia all have their 10-year sovereign yields up by 1.25 percent, the UK is up by slightly over 1 percent while New Zealand is up by 1.3 percent; even Eurozone and Japan have theirs up by 0.5 percent. Note their corresponding policy rates have generally been up by no more than 1 percent.
Such a move is often neglected by the general public because, from an economic perspective, most people borrow loans rather than issuing debt where the short rate affects them. From a financial perspective, most people participate in the stock and housing markets yet seldom trade fixed-income products. However, long yield affects the big loans and, hence, the large corporations. Remember, the 20-80 rule applies to economic drivers where 20 percent of firms (the giants) make 80 percent of GDP. High yield harms them and harms the economy, too.
The reasons for the long yield to surge are complicated, where economic growth outlook, inflation expectations, market sentiment, U.S. Dollar status, and fiscal healthiness could all be in play. Very often, it is not easy to tell which factor(s) is (are) dominating, and it is even harder to know in advance what kind of factors will be in play in which scenario. Let’s see some examples.
If talking about the ups or downs of long yield over some days to weeks, it is likely due to market sentiment where capital switching between risk-on and risk-off assets are driving. But if talking about the ups or downs over some months or quarters, it is likely due to macro changes, mostly business cycle movements (boom or recession) that are driving it. For ups or downs over years to decades, there must be some slow-motion long-term factors. These involve government fiscal soundness and inflation, in which the former affects the latter.
If a market crash or recession were to happen, the long yield should be falling instead of rising. Although the recent economic data improved, these seem not to point to a strong boom ahead. The recent yield surge could neither be explained by market risk-off; instead, the logic goes the other way around.
From a charting perspective, a technical breakthrough could be the reason (10-year neckline at about 4.5 percent), but technical without fundamentals cannot explain longer-term dynamics. By elimination, the only candidate left is inflation, which is still high.
Observe the U.S. long yield since the beginning of data history, it exhibits a 60-year cycle. The reasoning behind this is not well known but is likely to be due more to long-term factors like inflation than the short-term boom-bust cycles. Inflation is like a long-term sickness that is neither easy to build up nor possible to resolve in the short term. Anyway, the chart suggests our challenge will probably last till 2040!
KC Law, Ka Chung
