Bonds flashing ominous signs; Trade tensions to keep USD strong

The US Treasuries market is flashing warning signals. The USD is supported as trade war worries linger.
Eugene Leow, Philip Wee15 Aug 2019
    Photo credit: AFP Photo

    Rates: Ominous signs

    Respite from delay in import tariffs on selected Chinese goods did not last as major US stock indices declined by 3% overnight. Meanwhile, recession warnings from the US bond market got louder as 10Y and 30Y yields closed at 1.58% and 2.02% respectively. Weak macro numbers from China and the Eurozone likely  dented sentiments. With macro numbers staying firm, we argued that it would probably require tightening in financial conditions to prompt urgent Fed action. We could be close to this point if the equity market sells off further.

    We maintain our neutral stance on USD rates. Rates are very low by recent standards, but it still makes sense to have some exposure in US Treasuries given the highly uncertain outlook. Moreover, USD rates remain attractive compared to developed market peers. The technical picture (key support levels broke for USTs) and mismatched supply and demand in the DM space (USD 16tn of negative yielding bonds) suggest that there is further downside to US yields.

    It probably would not take much bad news to drive 10Y US yields back towards its all-time low of 1.36%. However, investors should also bear in mind that the bond market rally looks stretched. An overweight duration stance is vulnerable to any good news that has been sorely lacking in recent months.    

    FX: Trump needs to ease trade tensions

    The message from this week’s market volatility is clear and simple. US recession risks have increased from US aggressive trade policies on China hurting the rest of the world. Following weaker-than-expected China and European data (UK and Germany reported negative QoQ growth in 2Q19), major US stock indices plunged 3% in overnight markets from the side in the 30Y US bond yield to the Fed’s 2% inflation target. After having increased US tariffs to 25% from 10% on USD200bn of Chinese goods in May, Trump announced tariffs on the remaining USD300bn in September and labelled China a currency manipulator.

    Tuesday’s respite in global financial markets, however, signalled that not all is lost. Dow Jones rebounded by 400 points after Trump’s decision to pull back delay tariffs on some Chinese goods to December 15 from September 1. The plunge in the offshore USDCNH to 7.00 from 7.10 also signalled that the door has not closed shut for China-US trade negotiations, though the opening has gotten narrower. Chinese officials were reportedly still headed to Washington for the second round of face-to-face talks with US officials in early September. While no one expects any breakthrough, moving away from the mutual criticisms at the first round of talks in Shanghai would be a step in the right direction. Keeping the dialogue door open requires political will, and even more goodwill from Trump and continued patience from China to re-widen it


    Eugene Leow

    Rates Strategist - G3 & Asia


    Philip Wee

    FX Strategist - G3 & Asia

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