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Wall Street tanked on Tuesday and Asian stocks tumbled overnight, whilst the dollar rallied to a four-month high after US 10-year treasury yields hit 3%, the highest level since 2014, spooking investors. The rally in yields was in part due to rising inflation concerns and expectations of a more aggressive Federal Reserve this year.
The importance of 3%
3% is a closely watched psychological level for US treasury yields and the fact is has been breached dampened demand for US equities. Higher interest rate expectations mean higher corporate borrowing costs, in turn making investments more expensive. There is also the added concern that the Fed could decide to hike rates more quickly, or even too quickly which could slam the breaks on economic growth. Rising yields combined with disappointing reports from Caterpillar and 3M pulled the Dow over 400 points lower, whilst the S&P plummeted 1.3% and the Nasdaq 1.7%.
Equity market correction on the cards?
3% yields have not come out of the blue; the Federal Reserve has pointed to rising inflation since the start of the year and has been preparing the market for hikes throughout the year. Added to that, yields came close to striking 3% back in February, causing a correction in US equity markets. Whilst we are seeing a reaction to the 3% being struck, we are not expecting February’s reaction. At first glance this looks like a repeat of February’s yield rise stock tanks pattern; however, the market’s reaction is decidedly more measured this time. Not only have stocks stayed out of the correction zone so far, flows into the yen (the risk off trade) are no where near levels seen two months ago.
Dollar hits 4 month high
Declining geopolitical tension, particularly decreasing trade war fears have enabled traders to focus their full attention on dollar boosting fundamentals such as higher yields, causing the dollar to rally hard across the week. The dollar once again extended gains overnight, hitting a 4-month peak of 91.06 versus a basket of currencies. USD/JPY also hit a 2-month high of 109.2 overnight whilst the EUR/USD also fell, although has remained above $1.22.
Whilst the dollar has eased back in early trade, diverging interest rate expectations from the widening differentials for US and German or Japanese bond yields is expected to continue to support the dollar going forwards.
Following the selloff in equities on Wall Street and Asia, nervous investors are expected to send European bourses lower on the open. With no high impacting economic data due to be released in UK or Europe, investors are likely to remain focused on US yields and the currency markets in early trade.
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