USD: Higher yields weighing on risk appetite
The relentless move higher in US yields continues but there are some signs now that the move is having a bigger impact on risk sentiment. That is not a surprise – the only uncertainty was when precisely that might happen. The S&P 500 closed down 1.5% yesterday, fuelled in large part by higher rates – the US 10-year UST bond yield hit another new high of 4.56% (but has corrected a little lower) taking the gain to 51bps from the intra-day low recorded on 1st September. The S&P 500 is now down 5.2% in September and is down 7.2% from the record intra-day high recorded on 27th July.
Two factors in addition to the ongoing climb in yields may have played a part in this equity market drop. Firstly, consumer sentiment deteriorated with a sharp drop in expectations. The drop in confidence (103.0 from 108.7) was less significant than the much larger drop in expectations. The present conditions index actually increased marginally. Expectations fell nearly 10pts (to 73.7) and when you compare the difference between the present conditions index and the expectations index, it is clear that the breakdown remains consistent with recessionary conditions. Further rises in gasoline prices and falls in equity markets would impact expectations further and begin to impact consumers’ appetite to spend. If yields continue to move higher, at some point relatively soon we will see even larger equity market declines and a hit to the main engine of the US economy – the consumer. We don’t know but possibly expectations could be dragged further lower as pandemic-related excess savings held by consumers dry up. The San Francisco Fed estimated a drop from over USD 2.0trn to as little as USD 190bn by June.
The second factor is the looming government shutdown. The 2018 government shutdown was the longest on record at 34 days and didn’t have much impact on the real economy or the markets. There were a host of global factors and Fed tightening that prompted a huge equity market plunge in December 2018 but the shutdown itself was not a significant factor. The dollar did drop by over 2.0% during that shutdown. A shutdown certainly doesn’t help sentiment and with 1mn government workers potentially impacted, it could start to impact if it drags on longer than in 2018. This shutdown is also expected to be more broad than in 2018. For now, the US dollar continues on its strengthening trend. It is very stretched though after the DXY recorded its tenth consecutive week of gains last week and perhaps a government shutdown that draws increasing attention might be the catalyst for at least a temporary correction. Still, an equity induced drop in yields seems a more plausible trigger for an FX reversal and the 10-year yield is now 5bps down from the high yesterday.
