Focus shifts back to yields

Optimistic sentiment makes it into another global session intact, though accelerating Treasury yields are a renewed concern.

“Groundless” boost

Relative stability in risk-seeking markets is at least partly due to a pause in news flow on trade after an action-packed start to the week. Investors have been mostly just left with the Premier of State Council’s reiteration of the same pledge offered by top financial and monetary officials for months. Talk of deliberate yuan depreciation was “groundless” Li Keqiang said. To all intents and purposes, it’s another incremental boost for risk-taking that underpinned Shanghai and Shenzhen equity indices again, and again exported the buying rationale over to European stocks and Wall Street futures. 

No thaw

An obvious flaw in that rationale is that the latest deterioration in relations has merely delayed worst outcomes rather than avoided them. There is no thaw—China has yet to accept the Treasury Secretary’s invitation to ice-breaker talks. Further escalation looks all but inevitable, and, any ‘dividend’ from lower-than-initially mooted tariff rates on the U.S. side may evaporate once mid-term elections pass and tariff rates are then possibly hiked, as political risk to the White House eases. Furthermore, whilst the best guess on China’s yuan intentions is the ‘black box’ model, the renminbi’s pattern of downward drift (5.3% lower this year) and the PBOC’s well-defined defence levels leave policy questions open. We continue to expect U.S.-China trade relations to worsen before they improve and that the lull in global markets’ sensitivity will prove temporary.

Miners buoyed

FTSE miners are again the biggest beneficiaries of steady calm with all blue-chip names higher. The belated entrance of HSBC among the week’s risers after Tuesday’s notable slip keeps the benchmark index above the flat line even after the gauge suffered a sharp setback from stronger than expected inflation data. The biggest sign yet that the death of the pound/FTSE correlation is exaggerated saw turbo-charged cable trim recently resilient consumer cyclical shares, already dented by Kingfisher’s latest profitability wobble. Inflation news worked the other way for banks. The kneejerk reaction to revived CPI volatility is to link it with rate expectations, despite ambivalent implications for growth and other consumer-led activity, that could eventually crimp the prospects of RBS, Barclays and Lloyds, which are firm on Wednesday. For now, bank shares are among sectors participating with gains in Continental markets, though STOXX’s mining-related basic resource index is again at the front, auto and parts shares are not far below. Further delay before Beijing responds to Washington’s invitation could be the point on which global investor consensus could begin to show cracks, even as the White House weighs an ex-ante pledge to counter-retaliate.

Dollar and 10-year yield reunited

Another key candidate for a broader inflection point could be renewed yield turbulence. U.S. stock index futures pare gains a couple of hours to the cash open as the 10-year Treasury yield notably holds above the angst point of 3% after touching 3.07% for the first time since May. For many, the only surprise is how long it took to get back here. A potential recoupling with the dollar, consolidation of which is being shortened as USD/JPY soars on risk appetite, should be the biggest worry for emerging market foreign exchange buyers. In Italy, continued pressure on Economy Minister Tria for a budget that adheres to Brussels prescription is beginning to lift BTP yields (and Spanish and Greek) enough for spread widening to resume. The euro is duly in retreat from Wednesday highs and more so from its latest failed attempt to crack $1.173. Prime Minister Theresa May’s reported rejection of the latest formula proposed by chief EU negotiator Barnier puts sterling under sharper pressure at last look. This is all grist for the next turn of the dollar’s grind.