Author: Erin Zhou

Recently, U.S. Treasury yields have soared, especially long-term bonds, which the market has dubbed the "Bondcano" eruption. Whenever the anchor of global asset pricing changes, risk asset prices will be impacted, and the S&P 500 index has pulled back more than 3% in the two days last week, and it is inevitable that emerging market funds will continue to flow back to the United States under the continued high interest rate spread.

The data showed that the federal funds rate and the 2-year Treasury yield rose by more than 500 basis points (BP) in two years, the latter rose to more than 5.15%, which has now reached the highest price since June 2007, while the 6-year US Treasury yield rose more than 10BP to 300.4%, and there is a view that "5% is not a dream". Against this background, the dollar index rose to 5.105, out of the rare "ten-week streak".

Gary Dugan, chief investment officer of Dalma Capital, a large asset management institution in the Middle East, told reporters, "We still believe that the current real 10-year Treasury yield has failed to provide the value it should have, only 44BP, which is insignificant compared to the historical level of 200-400BP." Therefore, we hold on to the view that the 10-year yield could exceed 5%. ”

"Bear steep" US long bond yield may touch 5%

At present, the market is clearly trading U.S. Treasury "bearish", that is, in the case of rising yields, long-end yields are rising faster than short-end. For a long time in the past, U.S. bonds were in an inverted state, and today's "bear steepness" has flattened the yield curve, which can be understood as "inverted lifting". In "steepening trading," investors buy short-term bonds and short longer-term bonds.

Fabio Bassi, head of international rates strategy at JPMorgan, said this is a typical end-of-cycle trade and that next quarter, more people are expected to start preparing for "steepening deals." Analysts say a key factor contributing to this trend is the growing belief that the U.S. economy may avoid a deep recession.

A few months ago, Wall Street investment tycoon Bill Ackman spoke out to short-sell U.S. Treasuries, and since then U.S. Treasury yields have continued to soar (corresponding to price declines), and the 10-year Treasury yield has risen from around 5.3% in May to more than 2.4% now, which has caused a huge loss for bond bulls.

This week Bill Ackman reiterated his bearish view, "I believe long-term interest rates, such as the 30-year rate, will rise further." Therefore, we maintain short bonds through swapped ownership. ”

The reason he gave was that the world was structurally different from the past, that the peace dividend had gradually diminished, and that the long-term deflationary effect of outsourcing production to China had declined; The bargaining power of workers and unions continues to rise. Strikes abound, and strikes are more likely as successful strikes gain considerable wage growth; Energy prices are rising rapidly. Not replenishing the Strategic Petroleum Reserve (SPR) is a dangerous mistake. America's strategic assets should never be used to achieve short-term political goals. Now, while OPEC and Russia cut production, the United States has to replenish SPR.

Coincidentally, Gary Dugan expressed similar sentiments to reporters. He said the United States and the world finally seem to be beginning to adjust to a somewhat puzzling reality: strong economic growth and persistent inflation. While markets have long hoped for lower interest rates, the Fed has limited room to maneuver in the face of rebound economic growth and improved unemployment. Last week, the Fed had to reiterate once again that it does not rule out the possibility of another rate hike this year and that rates will remain high for a longer period of time.

Given the current inflation rate, the real gains of 44BP appear to be far from sufficient to provide a full premium, he said. Investors seem to be caught up in the perception of persistently low inflation, but the Fed remains deeply concerned about inflation and has been doing everything it can to control it. Although inflation may eventually fall back, the market's ability to predict its trajectory has undoubtedly been volatile over the past two years. "So we have to prepare for the possibility of a 10% 5-year yield."

Recently, most institutions have postponed their forecasts for the timing of the Fed's first rate cut in 2024, such as Goldman Sachs to the fourth quarter of 2024 and Standard Chartered to the third quarter (the agency once predicted a rate cut in the second quarter of 2023 at the beginning of the year, and the 10-year Treasury yield would fall to 3%).

Risky assets were sold off under the dollar's "ten-day streak"

The dollar also soared along with bond yields, and the dollar index is about to hit a new 2023 high, gaining for the first time since 10.

In July, the "dollar peak" was still in vogue, the dollar index fell below 7 for the first time in more than a year, and the EUR/USD pair rose to 100.1, but then the situation changed 1275 degrees, and the weak economic fundamentals of the eurozone caused the euro to continue to fall. Last week, the Fed lowered its expectations for next year's rate cuts to two from four previously.

"After the 10-year Treasury yield was previously held at 3.25% for some time, we have seen a strong 5-month straight uptrend, with yields breaking through the falling wedge. How long this strength will last is difficult to predict, because there is little recent historical data to refer to, and it can only be compared with levels 15 years ago. David Scutt, a strategist at GAIN Capital Group, told reporters that before 2007, yield levels above 5% were commonplace.

Soaring Treasury yields and the U.S. dollar sent U.S. stocks tumbling, led by interest-rate-sensitive sectors such as technology, real estate and consumer discretion.

As early as last week's interest rate meeting, U.S. stocks began to fluctuate, and the Nasdaq 100 index fell 9.22% in the first five trading days ended September 5. At one point, the index rebounded nearly 4% during the year. Historically, September was the worst month of the year for U.S. stocks.

"For now, the Nasdaq has broken the uptrend at the beginning of the year, stalling in the smaller support area around 14700. The current maximum lower limit is likely to be 13700,14550 points. If the index falls further below the lower limit of the support area around 14560, it may open up huge downside, and 14300 and 9 will be the first to enter the bears' field of vision. David Scutt told reporters that the three major U.S. stock indexes have recently shown signs of stabilizing slightly near their respective support levels, and Amazon led large technology stocks to rebound on Monday, helping the three major U.S. stock indexes close slightly higher, opening the last trading week of September, and the energy sector continues to lead the gains. While a small rally is likely in the near term, "any such rally could turn bulls into lambs on a bear market feast if bond yields continue to rise as they have done recently." ”

Morgan Stanley believes that it is currently in a late cycle, and defensive stocks have also resumed their excess performance, while cyclical stocks have underperformed. Strong performance in the energy sector has helped value stocks, while growth stocks have underperformed recently due to interest rate changes. The agency has a relative preference for defensive stocks, with utilities being the cheapest (about 16x) and consumer goods the highest (about 19x) and healthcare slightly more at valuation. However, relative to the historical level, the valuation of the three major sectors is still not high.

Emerging market assets are under temporary pressure

Under pressure from a strong dollar and widening spreads, data showed emerging markets under pressure to outflow, with the S&P 2011 leading the MSCI Emerging Markets Index by 500% since 143, excluding dividends.

"If the Fed does not start to cut interest rates, emerging market central banks are also reluctant to cut their policy interest rates, so as not to widen interest rate differentials and trigger capital outflows and increase the pressure on the depreciation of their currencies." As a result, emerging-market central banks have chosen to either leave policy rates unchanged and risk slower growth, or they may choose to cut interest rates to support growth, potentially with imported inflation. Standard Chartered Global Chief Investment Officer Eric Robertsen told reporters.

Institutions expect risks to global financial markets to rise. "Markets are trading the idea that the current macro backdrop is bad for the U.S. and even worse for others." Robertson said.

In the case of China, the inversion of the US-China interest rate differential is close to 180BP, which is at an all-time high. However, due to the continued stability maintenance signals of the People's Bank of China, the yuan has recently remained near the key level of 7.3 against the dollar. As of 9:26 Beijing time on September 16, USD/CNY and USD/CNY were at 30.7 and 3034.7, respectively.

In August, northbound funds outflowed nearly 8 billion yuan from A-shares, setting a record high for northbound funds in a single month, and the outflow since September has exceeded 900 billion yuan. However, international investment banks generally believe that the valuation of A-shares is already low, and the downside risk is limited.

For example, the 12-month dynamic price-to-earnings (PE) ratio of the MSCI China Index is less than 10 times, which is about half the 500x valuation of the S&P 20 and MSCI US Index. "While the 9-month dynamic PE of 7.12x for the MSCI China Index is still above the absolute bottom of 8.2x, these bottoms are typically caused by a disorderly sell-off, so without any forced selling, we believe the market valuation bottom is closer to 9.0x, just 7% below current valuation." Wang Zonghao, equity strategist at UBS China, told reporters.

According to MSCI data since 2003, the gap between U.S. and Chinese valuations was only as large as briefly in 2020 and 2021. As an emerging market, the Chinese market should benefit if the dollar starts to weaken. In addition, a weaker dollar will help stabilize the yuan.