October 15, 2019
After a holiday in the bond market yesterday, markets are at full strength today. And we get to see how global markets digest the trade deal news of last Friday.
What was the response? Stocks ripped higher, globally. Yields were on the move, higher. Gold, lower (a signal of de-risking). And we had a broadly lower dollar, which should be in the early stages, following what was described to be a currency agreement between the U.S. and China.
While the media is toiling away, scrutinizing the merits of a deal that they never understood or thought the U.S. needed in the first place, the markets are beginning (very early stages) to price in a world where an indefinite trade war concern is removed.
Commodities have yet to move, but that is where the biggest wins should come, if this deal does indeed clear the way for fiscal stimulus, structural reform and ultra-easy global monetary policy to drive a boom-time period for the U.S. economy (and a legitimate recovery for the global economy).
Add to this, the risks surrounding a disorderly exit of the UK from the EU, appear to be diminishing rapidly.
Not surprisingly, with the above in mind, the market that was most clearly positioned for the worst-case scenario for the global economy, is reversing: global interest rates.
Below is the German 10-year government bond yield. With global central banks wrongly positioned for an indefinite trade war, market interest rates crashed after the December one-two punch by the Fed and the ECB (the Fed hiked rates and telegraphed continued mechanical tightening and the ECB quit QE). After formally selling 30-year German debt with zero interest back in August, this major benchmark interest rate finally bottomed when the ECB repented for its sins and announced it would restart QE in September. With the hints late last week that a trade deal was in the works, German yields have now surged 16 basis points since Thursday – and nearing a big technical test of the downtrend.
What about U.S. yields? Remember when everyone was panicked about a recession, being signaled by the yield curve inversion? As you can see in the chart below, the inversion (10y/2y) was short-lived.
The plunge in global market interest rates, and the yield curve inversion, were punishment for central banks being ignorant to the risks of a potential indefinite trade war.
So, now we have global central banks back in a defensive stance. And now we have a deal that may end the trade war (at least as a front-burner issue).
How soon will we see U.S. yields march back toward and above 2%?