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This article is more than 5 month old.

Weighing scale is tilting towards US; supportive for 10-year yield and DXY

Mini

The ‘US Treasuries’ have been the premier safe asset around the world for the past several decades and it is likely to continue to act as a key part of the portfolio for many investment managers.

Weighing scale is tilting towards US; supportive for 10-year yield and DXY
“Don’t put all your eggs in one basket”… we have heard this idiom many times. This means, one should not risk everything on the success of one venture and should be tactical while deciding on their investment strategy. And hence, the concept of ‘Asset Allocation’ plays a vital role for traders, hedge funds, investment managers.
The ‘US Treasuries’ have been the premier safe asset around the world for the past several decades and it is likely to continue to act as a key part of the portfolio for many investment managers. What matters to the treasury prices and yield are inflation, economic outlook, growth story, peer country’s yield, and not the least factor- 'central bank outlook.'
The hawkish tone flattens the yield curve (difference between short and long term yield decreases) and dovish tone steepens the yield curve (difference between short and long term yield increases).
Recently we had seen that US 10 year yield was again inching higher towards 1.37 percent after stronger than expected US job reports, which is primary indicator for Fed to consider for a tightening. Let’s check the outlook for the US 10 year bond yield and its likely impact on the USD and Rupee.
Fed’s tapering is on the way:
After the recovery story, now growth story of the US is unimaginable. The average US growth over the last 10 years is 2.06 percent and average inflation has been 2.14 percent. But look at the recent quarter’s GDP and inflation figure. Those seemed transitory to the market and Fed, but eventually, everyone was convinced that the given GDP and inflation above 4-5 percent could be permanent over the medium-term and the US could achieve their targets over the long run.
The higher liquidity worked very well for the US after a higher vaccination drive and reopening of the economy. And now, the time has come for Fed to tweak its policy stance. When everything is on the mark, Fed could announce get set and go for Tapering- (reducing bond-buying or lower liquidity support) and then finally could go for a rate hike in upcoming years.
The higher inflation, growth, tapering, and hike expectations affect the US short-term to long-term yields. The hawkish tone flattens the yield curve as short-term yield rises faster than long term, although both jump over the course of the tightening. As the growth story remains brawny, the flows shift from riskier EM to less risky DM or in this case US markets. In nutshell, the upcoming tapering announcement, either in Jackson Hole Symposium or next month’s policy, will help the US 10 year bond yield to resume its uptrend towards 1.53 percent to this year’s high of 1.77 percent over a short to medium term.
Unfavourable peer country’s yield
Apart from its own domestic fundamentals, what matters most to the US 10 yield is its peer country’s performance and their yield. The immediate peer country of the US includes Europe and UK. Firstly, both are engaged with Brexit concerns and their implication on the economy. Secondly, Europe shall not lift easy monetary policy support at the current juncture as many European countries are yet to deliver the economic figures.
Whereas, the UK has tried opening their economy and it will be almost a month from so-called ‘Freedom Day’- Reopening. But the political clash between UK PM Boris Johnson and Chancellor of the Exchequer- Rishi Sunak over environmental concern, social care funding, Austerity program, and covid restrictions could call for political turmoil in the UK. This could all be favourable for the US 10 year bond yield over German or UK 10 year yield.
Fed’s rising Overnight Reverse Repo operation
For Fed, the repo is intended to prevent overnight interest rates from rising too high ( as we had seen in 2019 when liquidity was scarce), and the reverse repo is conducted to avoid negative interest rates. Since April-2020, we have seen Fed is very much active in overnight reverse repo action as many firms do not know what to do with so much liquidity that it is not remunerated.
The Fed has recently increased the number of financial firms that can access this type of facility and raised interest in June from 0 to 0.05 percent that entities receive for carrying out the ‘reverse repo’ operation. Further, they have increased reverse repo as the US is approaching its debt ceiling or we can say that is forcing the Treasury to reduce the issuance of bonds and bills, to reduce its liquidity. Whatever the reason for tightening, the 10- year yield will remain well supported.
Technically speaking:
The daily chart of the US 10 year bond yield is very much self-explanatory. It took support perfectly at 50 percent retracement of the previous up move and has also formed double bottom around 1.13 percent. However, some pullback is observed in recent days but unlikely to sustain well at this level and could bounce back towards 1.53 percent to 1.77 percent. Overall, technical outlooks suggest a bullish bias for the same.
Outlook:
The US performance on an absolute or relative basis supports the bullish story for the US 10 year bond yield. The same could be seen confirming from the Fed in the upcoming event- either in Jackson Hole or in the September FOMC meeting. The rising covid cases in the US seem to have limited impact on the US growth as the vaccination rate is quite higher and thus business, industrial, or service activity are likely to remain unaffected.
Hence, Fed’s hawkish prospects are still inevitable. Thus, 10-year yield could be seen moving higher just like 2013 Taper part-1 and we could see a move towards 1.53 percent to 1.77 percent. And hence, US DXY could also jump higher above 93.50 over the short term and 95.50 over the medium term. The flows which are right now chasing riskier assets in countries like India could be seen impacted as hot money could flow back to the US or treasuries and Rupee could depreciate towards 75.30 to 75.50 over medium term.
—Amit Pabari is the managing director of CR Forex Advisors. Views expressed are personal.
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