The single most important price in global financial markets is and remains the 10-year US Treasury yield. It is an uphill struggle to get investors to agree to that, but this long-term US interest rate is the benchmark for what the safest long-dated risk is worth.
You may argue whether this is a price or a return (depending on whether you are on the lending or borrowing end), but the inconvenient truth is that we are still living in a US-dollar-driven currency system worldwide. Thus, this US benchmark is regarded as the safe-haven asset. Last week, we saw a major move in the price of this asset. Thus, it has become more attractive to buy into US government risk than into global credit risks elsewhere. In fact, compared to a few weeks ago, the difference is more than a third (i.e. from roughly 1.3% last November to almost 1.8% today).
The trigger for this move was the change in perception about central banks’ monetary policy, particularly that of the US Federal Reserve. After previously perceiving this policy as ultra-expansive, it dawned on investors last week that, with the economy normalising, monetary policy will have to normalise too at some stage. That said, pondering a revisitation of quantitative tightening measures did raise some jittery memories about the year-end crash in 2018 when the Fed was on ‘autopilot’ while tightening its balance sheet.
Conclusion for investors
From where we stand today, we can state that some tightening is a given, the road to quantitative tightening is far from assured, and the most important price in financial markets is now more in line with economic reality. In fact, we projected a 1.85% target on a three-month basis (see number of the week). This would leave limited upside from here on, barring any overshooting. How to deal with it? We think this raises some opportunities for the beneficiaries of higher yields, such as cyclical value sectors like oil & gas (as highlighted by our technical analysis team) and financials (as highlighted by our equity strategy team).
Number of the week