Is a tipping point near? Yellen to talk bonds with Congress

1. Yellen on the Hill

July could prove to be the month that marked a tipping point for world bond markets. After numerous hints and suggestions from policymakers, investors seem to have decided central banks are preparing to wind down their ultra-loose monetary policies. The focus this week will be on Fed Chair Janet Yellen’s semi-annual testimony to Congress on Wednesday, even though she is likely to stick with the line that one more hike can be expected this year.

How the market judges her words will be reflected in the Treasury yield curve. The gap between two- and 10-year yields has picked up this month since hitting its narrowest in almost 10 months in late June as investors wondered how an absence of inflation chimed with expectations of rate hikes. The chart below shows just how far yields have been compressed. The last time all maturities on the benchmark curve, from one-month bills to 30-year bonds yielded at least 1% was Sept. 12, 2008, the Friday before Lehman Brothers collapsed.

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2. BOJ fights back

Not all central banks are climbing aboard the policy-tightening bandwagon. The Bank of Japan on Friday offered to buy unlimited amounts of Japanese Government Bonds as a broad sell-off in debt markets pushed 10-year JGB yields to their highest since early February and significantly above BOJ’s target of 0% under its yield-curve-control policy. But will the BOJ be able to keep yields down when all around others are rising? And what will this mean for the yen? The BOJ may have to turn back from its slow stealth tapering efforts but it could mean spreads between Japanese yields and those in Europe, the United States or even in Australia will widen and the yen will become the preferred funding currency.

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3. Hidden strength

The latest Reuters poll for the euro/sterling exchange rate shows analysts expect the pair to barely move, stuck around the 88-pence level over the next year. But the pair’s actual performance differs markedly from the median forecast from the start of this year. Forecasts suggested sterling would strengthen against the euro but, instead, the euro is up nearly 5% higher since January. Some analysts say this reflects a strength in the euro zone economy they had not expected. Layer in continuing ECB taper-talk, and some skepticism about the possibility of the Bank of England raising rates this year, and the euro could strengthen further against the pound in the remainder of 2017.

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4. The heat is on

The second half of the year for US stocks is setting up for a battle among sectors as the tech sector flounders after the runaway gains seen earlier this year. The sector is close to ceding its crown as the year’s best performers to healthcare. At the other end of the table, telecoms have nearly slipped under energy stocks as the year’s biggest laggards. The remaining sectors are clustered around the 9% return on the broad S&P 500. Capturing sector shifts and beating the benchmark has become crucial for fund managers facing an onslaught from ETFs which now own more than a third of the top US benchmark.

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5. Waiting for wage growth

A key metric coming into sharp focus for financial markets is wage growth, or lack thereof, across most developed markets. While the global economy and corporate profits are on a synchronized upswing for the first time in more than six years, this is yet to trickle down to salary slips. With labor markets running at or near full capacity the pressure to raise wages is slowly rising. That could see profit margins getting squeezed at companies that are not able to pass on higher costs to their customers.

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