Following the comment by US Federal Reserve Chairman Jerome Powell last week that “we’re a long way from neutral at this point”, the 10-year US treasury yield spiked above 3 percent.
The decade-long bond market boom was largely fueled by rounds of quantitative easing or QE by the Fed in previous years.
The US government and companies were able to enjoy cheap funding during the time, but the extended low rates gave rise to asset bubbles.
Now that the Fed is reversing its policy, the corporate sector can no longer source funds at super low levels.
As interest rates keep normalizing, and the yield curve steepens further, asset prices could be under pressure.
In addition to raising rates, the Fed has also started shrinking the balance sheet by US$40 billion per month from the second half of last year, another factor that will impact the financial markets.
The market was expecting three rate hikes next year and another hike in 2020, and the Fed fund rate to peak at 3.25 percent. Powell’s remark has led market participants to revise their estimates.
Widely watched bond investor Jeffrey Gundlach expects the 10-year yield to hit 6 percent before 2020 or 2021.
Gundlach did not detail his rationale. But generally, tighter monetary policy or stronger economy can both lead to higher bond yields.
Another possibility is a massive sell-off by bond investors as they could deem that the bull phase on the bond market is ending.
“On the march! 10’s above 3 percent again, this time without financial media concern. Watch 3.25 percent on 30′s. Two closes above = game changer,” Gundlach wrote on social media.
The reaction of the US equity market to rising bond yield was calm, while that of Hong Kong was rather negative.
Why did these two markets show such divergent performances amid rising rates?
Probably because US tax reform and improving economic growth have lured capital into US markets and offset the policy impact, while markets elsewhere suffered from capital outflow.
This article appeared in the Hong Kong Economic Journal on Oct 8
Translation by Julie Zhu
[Chinese version 中文版]
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