Global bond yields are continuing to spike, sustaining momentum from Friday August 19th. Stock markets do not like this, and are set to fall if bond yields continue to head higher.
We warned readers that traders/investors may have it wrong. The markets quickly went from the inflation narrative to recession. These were bullish markets because a recession means demand killing which is great for taming inflation, but the most important point is the central bank cuts interest rates to spur the economy.
In this world where money is chasing yield, and needing to obtain more yield due to inflation, the stock market is the best (and quickest way!) to make this required yield to stay ahead. Lower rates also sees more money head into stocks as it doesn’t make sense holding bonds yielding really low. Especially if inflation continues to be persistent.
So what was the catalyst? It appears two major economic events shifted the market narrative.
First was the UK inflation. Europe is seeing larger inflation prints than North America, and it likely gets worse heading into the colder months due to their energy and natural gas issues. UK inflation came in over 10% hitting 40 year highs! The Bank of England is saying inflation will peak at 13% come October of 2022. Analysts at Citigroup see things differently. They expect inflation to head higher in 2023 with targets between 18-19%. Gas prices and geopolitics will play a large part.
And the second event was the FOMC minutes which were released on August 17th. These minutes give us an insight into what Fed members are thinking. This report indicated that more rate hikes are coming.
“With inflation remaining well above the Committee’s objective, participants judged that moving to a restrictive stance of policy was required to meet the Committee’s legislative mandate to promote maximum employment and price stability,” the minutes said.
US and global markets have been in rally mode on hopes that central banks might soften the pace of rate hike increases in Fall.
In order to understand where rates are going to go, we need to be watching the bond markets.
My readers know how important it is to watch the US 10 year yield (TNX) chart.
The ten yield yield is back above 3% at time of writing. This thing looks bullish. We had a breakdown below 2.70% a few weeks ago which got stock market bulls very excited. It appeared as if the ten year yield triggered a reversal pattern known as the head and shoulders pattern. We pulled up to 2.70% for the retest. No continuation though. Instead, we closed back above 2.70% creating a false breakdown or a fake out. A bear trap.
Yields are now rising and it looks like they have more room to go. Speaking about fake outs, this could apply to US stock markets as they pullback to retest our major support zones. If we close below, markets will head lower.
But it isn’t just the US seeing a rise in yields.
The 10 year UK Gilt is rising… and appears set to take out the highs formed in June 2022. If so, we are heading to Gilt levels not seen since 2013. With inflation rising in the UK, traders are expecting more rate hikes. But can the UK and Europe do it? The UK is at 1.75% while the ECB is flat at 0%. Higher rates could very well break the economy and perhaps even the financial system itself!
German bond yields are also rising. Notice the similarity to the US 10 year yield. Chart structure is similar. A breakdown has led to a fake out. Yields are rising and have more room to the upside.
If there is one European debt market to keep track of, it is Italy. Remember, rising yields in Italy led to an emergency ECB meeting a few months ago. Before the ECB raised interest rates, they created a new central bank tool known as the TPI program. Basically an acronym for a fancy way of saying the ECB will buy bonds to drop yields. Yields did drop slightly, but have recovered once again and are heading higher.
Italy has seen its Prime Minister resign, and new elections are upcoming. Italy and its debt market will be taking center stage when it comes to a possible European debt crisis.
Over in Japan, the 10 year yield is rising once again. The Yen has had its major cratering as the Bank of Japan (BoJ) did not raise interest rates as other nations were. The Yen did get a brief reprieve, but looking at the charts, I see another round of Yen weakness coming. And it is due to the markets shifting back to the inflation and more rate hikes narrative.
I did articles warning readers why the Bank of Japan is super important. Even saying this is the most important central bank in the world. The BoJ is doing unlimited printing to buy unlimited bonds to keep the 10 year under 0.25%. They will continue to do so. The big question is how weak will the Yen have to get before the BoJ may want to change policy? If the BoJ does, it will be one of the biggest financial events in recent history.
On a final note, last week, I warned readers that the US dollar is looking to continue its uptrend. I warned gold bulls that a stronger dollar will cause a major rejection at 1800. I also warned crypto investors that a major drop is coming. Both of this occurred on the back of a stronger US dollar.
The US dollar is now nearing a resistance zone. Will it break? With the price action currently seen in bond yields, I think we can make a good case for a break. But nothing is actually confirmed until this breakout happens.
This move in the US dollar is either saying that US interest rates are heading higher, and/or we are seeing fear. For fear, we tend to see money running into the safety of bonds. But perhaps in this environment, cash is king since bonds technically don’t beat inflation… and if interest rates are heading higher, then bond values will drop. But the VIX is also noting that there is some volatility and fear.
I myself am more interested in the idea that it is European and Asian wealth leaving their countries and running into the US dollar. As things get worse around the world, more wealth will find its way running into the safe haven/reserve currency that is the USD.
In summary, watch both the US Dollar and bond yields. If we see yields heading higher, expect more pressure on global stock markets.