Treasury Bond ETFs Weakening on Foreign Demand Concerns

Toni Houston
January 13, 2018

"As long as China continues to export goods to the USA on that basis, they'll need to invest dollars in something", said Guy LeBas, chief income strategist at Janney Montgomery Scott LLC in Philadelphia.

The US 10 Year yield rose to 2.59% Wednesday in response to the news, which marks its highest level since March 2017, while the US Dollar index dropped around 0.50% in the morning part of the London session.

There have been far more severe storms in recent years.

None proved to be the turning point and world markets kept on keeping on.

"That should have been good news for the USA dollar, but it's still trading very weakly - it's a weak dollar story", said Masashi Murata, currency strategist for Brown Brothers Harriman in Tokyo.

There's little to suggest the equity juggernaut is about to reverse either, at least not yet, with Wall Street chalking up its best start to a year since 1987 (and even though Black Monday on October 19 that year was the worst day in US market history, Wall Street still ended 1987 in the green).

When compared with real yields, which account for inflation, stocks aren't "particularly expensive", according to the Bank for International Settlements. With inflation still well below the Federal Reserve's 2-percent target, investors are watching for any sign of a pick up.

Brent crude prices hit $70 a barrel on signs of tightening crude stocks but settled off that level on Thursday, while a jump in energy shares helped lift US stocks.

According to Societe Generale analysts, the 3 percent USA equity risk premium, essentially investors' compensation for buying riskier stocks over bonds, is well below its 30-year average. The currency traded at $0.7867 US, which compared to levels around the $0.783 handle seen before the release. "But the earnings and economic outlook in Asia remains solid", said Yukino Yamada, senior strategist at Daiwa Securities.

Rising Treasury yields can pressure prices for Gold, but USD's slide helped Gold shrug off any impact.

A report that China could potentially slow or halt its purchases following recommendation from officials in Beijing could be inaccurate, media reported Thursday, citing a source in the Chinese government.

The State Administration of Foreign Exchange (SAFE), which oversees China's massive currency reserves, questioned the accuracy of the news in a statement published on its website on Thursday.

China's showing once again that it's not afraid to wield the clout of its hoard of Treasuries to catch the attention of US officials and the world's biggest debt market. While the US central bank has indicated that it sees three rate hikes this year, markets appear to be expecting fewer hikes given lagging inflation.

"One thing that has been really important to China is that the Treasury market is so deep and so liquid", said Amar Reganti, a fixed-income strategist at GMO's asset-allocation group, and former deputy director of the Treasury's Office of Debt Management.

From mid-2014 to January 2017, Beijing ran down its FX reserves by $1 trillion to just under $3 trillion. China is the largest foreign holder of U.S. Treasuries.

What was the market fallout?

The yield curve from two to 10 years steepened by six basis points on Tuesday, the most since November 2016.

The strategists question the reliability of the report because, if China really were about to stop buying US Treasuries and chose to telegraph it beforehand, then it would hurt itself by driving down the value of the bonds already held on the PBOC's balance sheet. The Fed holds $3.015 trillion of Treasuries for other central banks, down from $3.052 trillion in September.

And that is bad news for bond investors.

Their bid for bonds is relatively price-insensitive.

Inflation pressures have the capacity to prompt the Federal Reserve to drive the United States base rate higher, which would mean market interest rates (bond yields) also have to move higher.

Other reports by Ligue1talk

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