Investors are under siege. A growing proportion of bonds in Europe and Japan offer negative yields. The German and Japanese curves are negative out 15-years, while one cannot find a positive yield among any tenor of Swiss government bonds. Despite a string of robust data, US Treasury coupon yields are at record lows.
The US dollar had a good week. It was helped by the strongest service ISM this year, with strong gains in forward-looking new orders component and an increase in export orders. Non-farm payrolls snapped back from a downwardly revised 11k jobs (-6k private sector) to 287k (265k private sector).
It was the strongest employment gain in eight months. In addition, as more bonds denominated in euro, yen, and Swiss francs offer negative nominal yields, an increasing part of the world’s savings appear to be drawn to the positive returns of dollar-denominated paper.
The conventional narrative has it backward. It worries about the threats to stability emanating from the periphery in Europe. Policymakers, investors, and economists still refer to the “Greek, Irish, Portugal and Cyprus’ bailouts. The biggest threats do not come from the periphery but the core. The peripheral countries were not bailed out, the official and many private sector creditors were made whole.
What a difference a few days make. Many saw last week’s equity market advance a sign that Brexit anxiety was overdone. However, quarter-end position adjustments appear to have been misread. Equity markets are falling now. Bond yields in the US, Japan, and Germany, are at new record lows. Japan’s 20-year bond yield briefly dipped below zero for the first time.
Monday, while Americans were celebrating the original Brexit, the US dollar drifted lower. The Australian dollar fully recovered from electoral uncertainty drop to finish about 0.5% higher. Asian and emerging market equities rallied, but Europe faltered. The MSCI Asia-Pacific Index gained 0.8% to extend the advancing streak to a fourth session. MSCI Emerging Market equity index extended its streak to five sessions by rising 0.5%.
There have been two developments that are shaping investment climate. The first was the dramatic rally in equity markets last week, with many recovering nearly all that was lost on the Brexit wobble. The second was clear indications that the UK will not begin the formal divorce proceedings in the coming months.
That had seemed likely when Cameron said he would leave it to his successor. However, the leading Tory candidates are suggesting that Article 50 will not be invoked this year.
The US dollar turned in a mixed performance in the week after the UK decision to leave the EU. There was an acute market reaction for a couple of days, but the disruption to the financial system was not major.
Officials and investors feared worse. The initial line of defense, central bank swap lines were barely used. The Bank of Japan was the only central bank to draw on the Fed’s lines, and even then, the amount was inconsequential ($2 million).
The US dollar is little changed ahead of what will likely be a thin North American session due to the US holiday on Monday. The Australian and New Zealand dollars are attracting flows, ostensibly as a place to park funds, even though tomorrow’s Australian election looks a dead heat.
After plummeting 18.6 cents, mostly in a few hours after it became clear that the Brexit would carry the day, sterling has rallied four cents from the low set on Monday. We recognized that the magnitude of the drop left sterling technically over-extended, but we caution against suggestions that the worst is behind us and that a durable low is in place.
This week’s high so far was recorded on Monday around $1.3565. Today’s high has stopped short of this, and beyond it is last week’s close near $1.3680.
No fundamental development can compare with the UK decision to leave the EU. It has set off a chain reaction whose outcome is still far from clear. Sterling is firm, alongside most of the major and emerging market currencies today. Sterling narrowly edged above yesterday’s highs to reach almost $1.3425 before encountering selling pressure.
