The Real Story Today: Rates, Not Tweets

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The Real Story Today: Rates, Not Tweets

We continue to stare at the German 10-year Bund yield with morbid fascination:

  • After today’s dovish comments by Mario Draghi, it fell to -0.32%, an all time low. Invest 1,000 euros in a Bund and in a decade’s time you are sure to have 997 euros. Guaranteed.
  • Even Japanese 10-year sovereigns aren’t that bad; they “yield” -0.13% today.
  • No other European sovereign debt yields declined today – this was clearly Germany’s party (likely because unlike the rest of the continent, its fiscal budgets actually balance, making the Bund the world’s least risky financial asset by at least that measure).

And even after President Trump’s tweet about his upcoming G20 meeting with President Xi, Draghi’s comments and their impact on the Bund found their way to US 10-year Treasuries:

  • Yields here fell to 2.06% but were as low as 2.03% before Trump’s tweet but after the Draghi headlines. These are the lowest yields back to September 2017.
  • To be fair, inflation expectations have been plummeting in recent days (another data point we regularly stare at in some disbelief).
  • The spread between 10-year TIPS bonds and Treasuries now reflects an expectation of just 1.63% inflation over the next decade. That is a new low back to October 2016.

As far as how much credence markets gave to a real rapprochement between the US and China, the offshore yuan is signaling “not much”:

  • The yuan rallied 40 basis points to 6.90/dollar, which admittedly is a decent move in currency land.
  • But remember that the offshore yuan fell by 3% in the first half of May as it became clear that a near term resolution on trade was not possible.
  • Bottom line: with the yuan at 6.90/dollar versus where it was when a deal seemed likely (6.70/dollar), currency traders seem skeptical that next week’s G20 meeting will deliver any sort of breakthrough.

The final markets data point that we’re focused on at present is the dollar:

  • Looking at the DXY Index, the dollar is still just 0.5% away from its one-year highs.
  • Based on the Fed’s trade-weighted index, the dollar is less than a percent away from its all-time high back in 2002.
  • Either way you look at it, the dollar remains strong.
  • As much as the fixed income market has baked in a series of Fed rate cuts (as we covered last night), the dollar’s strength still makes sense given the US’s better economic growth and higher relative interest rates.
  • The risk to equities, however, remains. Some 38% of the S&P 500’s revenues come from non-US sources and a dollar breakout to new highs will hit bottom line results.

The bottom line to all this: sometimes one day’s market action is a perfect reflection of the prevailing market macro narrative, and this was one such session. Long run rates are trending lower, supporting equity valuations. And there’s just enough hope for a trade deal to keep stocks in rally mode, even if other markets remain unconvinced.