Following are five big themes likely to dominate thinking of investors and traders in the coming week.
Bonds On The Run
U.S. Treasuries—and maybe financial markets across the world—are at a critical juncture. The bond selloff is gathering pace, pushing 10-year yields above 3 percent to the highest since May and within sight of levels last seen in 2011.
Is this the breakout, the reversal of the 30-year bull market, that some people have spent years predicting? If 10-year yields break above 3.128 percent, that view will gain credence. There are still plenty of political, fundamental and relative valuation reasons for buying bonds. But once a market move picks up momentum, it can be hard to stop.
The 10-year Treasury yield matters because it is the rate against which trillions of dollars of borrowing around the world are referenced. It touches every market in the world.
But markets, curiously, are not paying as much attention as one would expect. Wall Street sailed to new highs in the past days, emerging market stocks are up four weeks out of the last five, and market volatility remains low. Even Treasury market volatility. It could get more interesting over the week.
Waiting For the Fed
A rate hike at the U.S. Federal Reserve’s Sept. 25-26 policy meeting is all but certain—taking the rate to 2.00 percent-2.25 percent. And the odds have also increased for a December rise and more bumps up into 2019.
But market watchers have already turned their attention to the question of when to call the next economic downturn.
The traditional indicator is the yield curve inverting—in the United States, this has been a pretty accurate predictor of recessions. However, another interesting sign could be read from the relationship between the fed funds rate and employment.
The fed funds rate has risen above the employment rate ahead of prior recessions—and the unemployment rate, currently 3.9 percent, is now near the lowest in 18 years.
So the fed funds rate and the employment rate are still a far bit apart. But they are inching closer and another hike will trim the gap a little bit more.
RRR-Allying the Troops
Much of the emerging market universe is in a rush to tighten monetary policy, but in China speculation is rife that authorities will ease reserve requirement ratios (RRR) again.
For one, the pattern of this year’s RRR cuts has been a quarterly one. Second, the economy has been looking more sluggish. And finally, new U.S. tariffs of 10 percent on about $200 billion of Chinese products will kick in on Sept. 24, rising to 25 percent by year-end. China’s retaliatory tariffs on 5,207 U.S. products also enter into force in the coming week.
With trade wars set to take a toll on the economy, Chinese authorities, despite a campaign to curb risky financing, may have little choice but to provide support. Not via any grand stimulus plan, but through targeted measures, such as cutting RRRs.
The problem is that monetary easing will pressure the yuan, which is not far below the key 7-per-dollar level, the rate that in past years tended to inflame capital outflows. Those outflow fears are less than they used to be. But policymakers will still have to tread carefully.
Of Budgets and BTPs
D-day looms for Italian government debt markets. Known as BTPs, the bonds are trading nervously before the Sept. 27 deadline for Italy’s coalition government to present details of its 2019 budget. Focus will be on the budget deficit, the cause of months of investor angst.
In one corner is economy minister Giovanni Tria. Unaffiliated to any party, Tria has assured markets he will keep the deficit below limits stipulated by the European Union—3 percent of annual GDP. That pushed Italian risk premiums steadily lower over the summer—10-year yields are more than 50 bps off end-May highs.
But Tria is up against coalition cohorts Luigi Di Maio and Matteo Salvini, deputy prime ministers, who have become increasingly vocal in urging more spending to meet election promises.
The horse-trading has raised market volatility. But longer-term, a rules-busting budget that raises conflict with the EU, could trigger a credit ratings downgrade and foreign investor exodus. And all that could hit just as the ECB’s bond-buying program nears its end.
Emerging From the Darkness
Don’t say it too loudly, but the emerging market tornado might just have blown itself out. The principal reason is the dollar’s sudden loss of power, as well as China’s reassurance that yuan devaluation is not on the cards. But the coming week could make or break the rebound—hinging on whether the Fed meeting ends up recharging the dollar or if Beijing’s retaliation to U.S. trade tariffs is harsher than it has signaled.
But there have been other changes too—for instance, Turkey’s whopping interest rate rise that stabilized the lira and signs of progress in Argentina’s talks over an IMF loan. Some prominent investors have also said the selloff might be overdone—many currencies are trading well below what could be considered fair value.
There is a blizzard of data from the likes of Brazil and India and plenty of central bank meetings too and it will be copper powerhouse Chile’s turn to lay out its budget.