US rates rose again overnight, after (unverified) reports that China was considering slowing or stopping US Treasury purchases. US stocks and the USD fell in response to the story, although the initial moves have mostly unwound. The NZD broke through 0.72 overnight but has since has come back.
Bloomberg reported overnight that (unnamed) Chinese officials had made an internal recommendation to slow or reduce purchases of US Treasuries. The report referred to the outlook for US debt and trade tensions with the US as two factors that might make US Treasuries less attractive. The report didn’t state whether the recommendation had been adopted. The market was already wary of a pick-up in bond supply this year as the US Treasury finances Trump’s tax plan and the Fed reduces its purchases. The 10 year US Treasury yield, which yesterday broke above 2.50% for the first time since March, extended those rises overnight. The 10 year rate sits at 2.58%, up 3bps on the day and close to its highest level since 2014. In contrast, 2 year Treasury yields and foreign bond markets were mostly unchanged.
We would be cautious about reading too much into the report, although the market reaction does highlight the negative sentiment towards bonds at present. China holds $1.2tn in US Treasuries and there are no bond markets that offer the same kind of depth or liquidity for a holder of that size. Second, until China moves to a fully floating FX regime, FX intervention to slow CNY appreciation will continue to generate demand for USD assets.
The S&P 500 initially fell 0.4% after Bloomberg’s report, but it has since recovered those losses. Likewise, the USD fell after its release, with the EUR rising almost a cent, above 1.20, before mostly retracing this move. The NZD spiked up to 0.7230 but it too has moved back down and now sits a little below 0.72.
The top performer in FX markets was again the Japanese yen, extending its gains from the previous night after the BoJ reduced its purchases of longer-dated JGBs. The yen is up almost a percent since this time yesterday. The 10 year JGB yield is 9bps, close to the top of the BoJ’s implicit target range of -10 to +10bps. The BoJ has stepped in to buy unlimited amounts of JGBs when this level has been breached in the past. The market remains very sensitive to any signs that central banks are stepping back from QE and will be closely monitoring the BoJ’s response if yields rise further. We would expect the yen to appreciate further if the BoJ does not step in above the 10bp level.
The GBP was one of the worst performers in FX overnight after a weaker than expected trade balance release. The market brushed off better than expected industrial and manufacturing production data and comments from BoE Deputy Governor Ben Broadbent that the BoE intends to keep tightening. The NZD/GBP reached its highest level since mid-October overnight and currently sits a bit above 0.53.
The focus in the day ahead will the release of the minutes to the ECB’s most recent meeting. The market will be attuned to any discussion on the outlook for QE beyond September. Ahead of the all-important US CPI release on Friday, we receive PPI tonight (although the correlation between core PPI and core CPI is not terribly great). Australia releases retail sales as well.
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