By Chan Kung and Wei Hongxu
Since February this year, U.S. 10-year Treasury yield has been rising steadily. The yield broke through the 1.6% mark again on March 12, rising to 1.625%, after U.S. President Joe Biden signed into law a new USD 1.9 trillion stimulus package. Compared with 0.916% at the end of last year, the yield on the 10-year Treasury note has now risen by 0.7 percentage points. Judging from this rising yield, the trend toward higher interest rates in the U.S. is likely to remain for some time to come. The global monetary environment of zero/negative interest rates since last year is undergoing a change, which is bound to bring about a repricing and structural impact on the global capital market.
In view of the fundamentals of the rising U.S. Treasury yields, ANBOUND has mentioned that, on the one hand, the consequences of the Fed’s ultra-loose monetary policy last year are emerging and the U.S. economic recovery prospects are relatively optimistic. On the other hand, inflation expectations caused by the new round of stimulus in the U.S. are clearly rising, at the same time, the Fed’s potential for a stronger yield curve control policy is also leading interest rates higher. Judging from the performance of the market, investors are not panicking as they were at the end of February, this trend is being gradually digested by the market, and many institutions are starting to reposition their investments in the belief that the current rise in Treasury yields is far from over. Deutsche Bank raised its year-end target for the U.S. 10-year Treasury yield by a full percentage point to 2.25%. Analysts at ING made clear that the yield on the U.S. 10-year Treasury note is likely to be well above 2% in the second quarter as the U.S. economy reopened and a USD 1.9 trillion fiscal stimulus package rolled out.
From a global perspective, the rise in interest rates is not an isolated phenomenon, but a common trend in major economies. Gao Shanwen, chief economist at Essence Securities, said bond yields in almost all major economies are rising. Compared to pre-pandemic levels in early 2020, Japan’s long-term bond yields, after a rapid rise, are already significantly higher than they were before the pandemic. Meanwhile, long-term bond yields in France and Germany have at least reached pre-pandemic levels, while U.S. bond yields are 30 to 40 basis points away from pre-pandemic levels. In this sense, the rise in U.S. bond yields is relatively modest. The current situation shows that although the current trend of global inflation is not obvious, the economy of developed countries is recovering rapidly under the circumstance of the continuous increase of global money supply and the popularization of vaccines in developed countries. This has led to inflationary expectations, which also means global liquidity easing is facing a “turning point”. Real interest rates are starting to return to pre-pandemic levels (zero interest rates) as nominal interest rates and inflation expectations rise.
In fact, according to a survey by BofA Securities, institutional investors have already begun to adjust their portfolios in response to rising interest rates. Therefore, although the rise in bond yields has not caused volatility in the U.S. stock market, a major structural change has taken place. On March 12, bank stocks rose on expectations of higher interest rates, with Wells Fargo and Citibank up more than 2% and JPMorgan Chase and Morgan Stanley up more than 1%. Meanwhile, U.S. industrial stocks continued to strengthen, with Boeing and Caterpillar up 6.82% and 4.2%, respectively. Growth stocks, on the other hand, generally fell, with Apple and Amazon down around 0.76%, Netflix down nearly 1% and Tesla down 0.84%. According to insiders, sustained rise in 10-year Treasury yields will fuel market expectations of rising inflation, pushing up prices of commodities such as crude oil, copper and aluminum, and putting downward pressure on gold prices. This change suggests that global capital markets are repricing and revaluing the rise in interest rates.
This trend in capital markets suggests that the growth-induced “taper tantrum” could return. In 2013, as the U.S. economy improved, the Fed gradually suspended its quantitative easing program, causing the “taper tantrum”, which led to the turmoil in the capital market and the bursting of the bubble. In this case, as ANBOUND has warned that liquidity “wiped out” in a capital market bubble will lead to increased demand for U.S. dollars and a return of U.S. dollar capital, affecting emerging markets including China. Liu Yuhui, a researcher at the Chinese Academy of Social Sciences, stated that “only after experiencing fiscal deficit expansion – rising interest rates – volatility in asset prices – the periodic elimination of redundant currency and credit, can the country make room for the next round of quantitative easing.” Under such circumstances, if the U.S. government continues to push the stimulus package and expand fiscal spending, it will inevitably promote a strong dollar policy, “wiping out” the overseas dollar liquidity while the policy rate
Due to the huge domestic market space and capital market regulation, China will be less affected. Meanwhile, the containment of the pandemic in China and the apparent economic recovery will make China’s capital market favored overseas. Therefore, the impact of U.S. dollar liquidity disturbance on China’s capital market is limited. However, the rise in global raw material prices is putting pressure on China’s domestic inflation and corporate earnings. At the same time, the constant flow of international short-term capital under the mechanism of “Shanghai-Shenzhen-Hong Kong Stock Connect” will also bring significant volatility to the domestic capital market, while the narrowing of interest rate differentials between China and the U.S. will also put pressure on the RMB exchange rate. Therefore, China needs to guard against risks and “stabilize leverage” to ensure the stability and development of the capital market. Above all, past perceptions of the global financial environment of “low growth, low inflation, and low interest rates” need to be changed to avoid misjudgments.
Final analysis conclusion
The repeated rise in U.S. Treasury bond yields indicates that the pick-up in interest rates has become a periodic trend. This trend will bring about a change in global liquidity, which may cause a revaluation and repricing of capital markets. This imminent liquidity “turning point” needs to be adequately estimated and addressed.
About the Authors
Founder of Anbound Think Tank in 1993, Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing.