- Relentless rally in bond yields crushes the Japanese yen
- But stock markets don’t get the memo, keep grinding higher
- UK spring budget and another dose of Powell coming up
Yen pain trade
Global bond yields continue to power higher, eclipsing pre-pandemic levels with the blessing of central bankers who are desperately trying to put the inflation genie back in the bottle. Investors are essentially dumping bonds in a fire sale manner, worried about suffering further losses on the price as interest rates climb.
When there’s so much selling pressure, the price of a bond drops and the yield increases to attract new buyers. And since bond yields are simply market-determined interest rates, the latest spike means that the price of money has just gone up. That has spillover effects for every asset class.
The recent demolition of the Japanese yen speaks for itself. The Bank of Japan does not allow domestic yields to rise beyond a certain level, so the yen gets bulldozed whenever foreign yields edge higher and rate differentials widen against it. Dollar/yen has risen 5% just in the last three weeks, which is a massive move in currency terms.
Stocks don’t get the memo
The relationship between the stock market and rising yields is more complex. In theory, rising yields should spell trouble for equities, especially for shares of companies with rich valuations. But in reality, rising yields are often a sign of a strong economy, making it easier for share prices to absorb them.
Stock markets have recovered with breakneck speed over the past week, leaving traders scratching their heads as to what’s driving the furious rally. After all, the risks that torpedoed risky assets this year are still active - inflation continues to heat up, the war is raging, and central banks are taking the gloves off.
Some analysts point to aggressive short covering by hedge funds as the catalyst behind this rebound, while others suggest quarter-end flows are driving the ship. It may be even simpler - the economy is not imploding and real yields are still deep in negative territory.
Gold, sterling, and Powell
The inability of real yields to stage a convincing rally may also be what has allowed gold to outshine its safe-haven competitors this past week. Whereas bond prices and the Japanese yen have been decimated, bullion has been incredibly stable because inflation expectations remain elevated, keeping real yields underwater.
Meanwhile, the revival of risk appetite has breathed life back into the British pound, which continues to trade like a proxy for equities. Whether this recovery has legs will depend on the Chancellor, who will unveil the Spring Statement today. He is likely to push forward with an increase in national insurance, so the question is, will he cushion the blow for consumers by also slashing fuel taxes?
Finally, Fed Chairman Powell will deliver some remarks at 12:00 GMT. The Fed seems determined to use this inflationary window of opportunity to raise rates as much as possible, essentially loading up on ammunition to fight the next recession. Markets are pricing in another 7-8 quarter-point rate hikes for this year and the sanguine reaction to the latest spike in yields might give Fed officials the green light to stay on the offensive.