All Eyes On The 10Y Treasury Which Is Blowing Above 2.60%, Nears Gundlach's 'Redline'

The meltup continues: European stocks edged higher as Asian shares traded mixed, while U.S. equity futures point to another open in record territory. However, today's story may not be stocks, but rather rates as U.S. bonds extended the Wednesday selloff with the 10-year Treasury yield climbing above 2.6% for the first time since March to help the dollar hold Wednesday’s gain.


The catalyst for the ongoing selling in the rates complex was China, and specifically the barrage of Chinese data reported overnight.

For the better part of the past decade, "bad news was good news" for stocks as it meant more central bank support. Now, good news is even better news - at least until central banks realize they can't withdraw - and the push into new record highs across global risk assets overnight is being attributed to the latest set of stronger than expected Chinese economic data released overnight, which beat across the board with the exception of retail sales.

    China GDP YoY BEAT: +6.8% vs +6.7% exp (+6.8% prior)
    China Industrial Production YoY BEAT: +6.2% vs +6.1% exp (+6.1% prior)
    China Retail Sales YoY MISS: +9.4% vs +10.2%% exp (+10.2% prior) - lowest since Feb 04
    China Fixed Assets Investment YoY BEAT +7.2% vs +7.1% exp (+7.2% prior)

However, as we said yesterday, despite the occasional blip the trend remains all too clear.

As a result, and as Bloomberg confirms, the Treasury curve is in focus as 10Y yield breaks above the key 260bps level - which Jeff Gundlach last week dubbed as a red line for not only an accelerated selloff but the level above which it will start hurting equities - leading curve steeper as Apple repatriation announcement remains in focus with speculation the firm may have to sell some Treasuries to pay the tax liability.

Treasuries also retreated amid hopes that U.S. lawmakers will strike a deal to avert a government shutdown before temporary funding runs out on Friday, after Chief of Staff Kelly said the GOP has the needed votes to pass the stopgap bill. China’s better-than-expected data only added to the narrative of synchronized expansion, which - alongside upbeat profit expectations - could mean the bull run in stocks going until 2019 or beyond, according to a Bank of America survey of fund managers.

In response to the push higher in US yields, Germany’s 10-year bond yield, the benchmark for the region, was near a 5-1/2 month top at 0.52%.

Away from the bond reaction, most Asian equity bourses were closing when the Chinese data landed but had briefly set a new an all-time record after the U.S. bluechip Dow Jones Industrial index had closed above 26,000 points for the first time.Australia's ASX 200 (Unch.) and Nikkei 225 (-0.7%) both gained at the open in which the Japanese benchmark briefly rose above the 24000 level for the first time in around 27 years, although both then pared gains with Japanese stocks sliding into the close, while commodity-related stocks in Australia were dampened by disappointing production updates from Whitehaven Coal and Woodside Petroleum. Elsewhere, Hang Seng (-0.1%) and Shanghai Comp. (+0.5%) were varied in anticipation of tier-1 China data releases including GDP in which officials including Premier Li had suggested the economy grew 6.9% for 2017. China's yuan finished at its highest since December 2015. 

Europe's main FTSE, Dax and CAC40 stock markets then ticked higher though moves were choppy in the cross currents of rising euro and bond yields. The euro strengthened while European stocks were mixed, with the technology sector lifted by Infineon (+4.5%) after upgrade by Goldman. The FTSE 100 was struggling thus with the index dragged down by the likes of Whitbread after a soft earnings report

“The likelihood we have higher inflation data in the big economies is well over 50 percent so that is the next turning point for the markets,” SEB investment management’s global head of asset allocation Hans Peterson told Reuters. He added there were now two big questions. How will central banks respond and will the rise in bond yields happen at such a pace that it impacts optimism around assets like equities?

We are going to change the regime probably within the next 2-3 months,” he said. “Will it be accompanied by rising producer prices then we can live with higher bond yields, otherwise it is a problem for us.”

In FX, the break higher in U.S. yields, supposedly launched by news of Apple's cash repatriation even if as Morgan Stanley explained the market reaction was wrong, helped the dollar rise from a three-year low hit earlier in the day in Asia. The euro last stood nearly 1.225 but below a peak of $1.2323 set on Wednesday, the euro's strongest level since December 2014.

A number of top ECB policymakers were due to speak in Frankfurt. Some may have been caught off guard by the speed of the euro’s appreciation, said Lee Jin Yang, macro research analyst for Aberdeen Standard Investments in Singapore. “Maybe they are trying to manage volatility or slow down the rise,” Lee said referring to Austria’s Ewald Nowotny who told reporters on Wednesday that the euro’s recent strength against the dollar was “not helpful.”

Emerging markets were gearing up meanwhile for a number of key interest rate meetings including in Turkey where last year’s 18 percent slump in the lira versus the euro has got inflation back in double digits. South Africa's central bank also meets. After being sickly for much of 2017, a sounder political backdrop has seen the rand surge. ZAR is one of the best performing currencies in the world so far this year, fuelling talk of a possible rate cut.

“The South Africa meeting is the big show today. People are in it, they want to like it they want to own it,” said UBP’s EM macro and FX strategist Koon Chow. “So any dovishness or a cut would be another trigger for another leg higher.”

The rising U.S. bond could cause turbulence for EM debt markets, however. As well as the gains for benchmark Treasuries, The two-year yield US2YT=RR hovered at a nine-year high of just over 2 percent. “In emerging markets we are trained like dogs,” Chow said about the rising yields. “When we hear that bell ring we want to just run,”

In commodities, crude oil prices rose earlier on data showing a decline in U.S. crude inventories and as rebels in Nigeria threatened to attack the country’s petroleum infrastructure, before trimming their gains.  U.S. crude futures were 2 cents higher at $63.99 a barrel have hit a three-year high of $64.89 on Tuesday. Spot gold was down 0.1 percent at $1,327.56 an ounce, with the dollar’s bounce pulling it back from a four-month high of $1,344.43 set on Monday.

IBM, Morgan Stanley and American Express are among companies scheduled to publish earnings. Economic data due include housing starts and jobless claims.

Top overnight news from BBG

  • A small shift is taking place in internal discussions among Bank of Japan policy makers, with a minority raising the need to eventually start discussing policy normalization, even though they agree the current stimulus program must continue unchanged for some time, according to people familiar
  • Republicans are betting Democrats won’t risk forcing the government to shutter during an election year to press their demand for a deal on immigration by Friday’s funding deadline.
  • Theresa May’s hopes of thawing frosty relations with Donald Trump at a meeting on the slopes of Davos next week look to be fading, according to people familiar with the matter.
  • China’s holdings of Treasuries fell to a four-month low even as its foreign-exchange holdings increased in November, in a potential sign the world’s second-largest economy is curbing its appetite for U.S. government debt
  • Barclays Plc is eliminating as many as 100 senior staff at its underperforming investment bank division; cutbacks will fall mainly at the managing director and director levels and are evenly split between Europe and the U.S., according to people familiar with the decision

Market Snapshot

  • S&P 500 futures down 0.09% to 2,801.25
  • Brent Futures down 0.09% to $69.32/bbl
  • Gold spot up 0.1% to $1,328.76
  • U.S. Dollar Index up 0.2% to 90.71
  • STOXX Europe 600 up 0.07% to 398.25
  • MSCI Asia Pacific down 0.3% to 182.18
  • MSCI Asia Pacific ex Japan up 0.2% to 595.48
  • Nikkei down 0.4% to 23,763.37
  • Topix down 0.7% to 1,876.86
  • Hang Seng Index up 0.4% to 32,121.94
  • Shanghai Composite up 0.9% to 3,474.75
  • Sensex up 0.5% to 35,258.78
  • Australia S&P/ASX 200 down 0.02% to 6,014.57
  • Kospi up 0.02% to 2,515.81
  • German 10Y yield rose 2.2 bps to 0.584%
  • Euro up 0.3% to $1.2218
  • Brent Futures down 0.09% to $69.32/bbl
  • Italian 10Y yield rose 2.9 bps to 1.732%
  • Spanish 10Y yield rose 0.5 bps to 1.507%

Asia stocks were mixed as the region faltered in late trade and gave up the momentum from Wall St. where the S&P 500 and DJIA closed above 2800 and 26000 respectively amid earnings optimism, as well as reports that Apple is to repatriate some of its cash holdings and invest in the US. ASX 200 (Unch.) and Nikkei 225 (-0.7%) both gained at the open in which the Japanese benchmark briefly rose above the 24000 level for the first time in around 27 years, although both then pared gains with Japanese stocks sliding into the close, while commodity-related stocks in Australia were dampened by disappointing production updates from Whitehaven Coal and Woodside Petroleum. Elsewhere, Hang Seng (-0.1%) and Shanghai Comp. (+0.5%) were varied in anticipation of tier-1 China data releases including GDP in which officials including Premier Li had suggested the economy grew 6.9% for 2017. Finally, 10yr JGBs were flat uneventful with early short-covering seen in prices after yields rose to a 6-month high of above 0.08%. Furthermore, mixed 30yr auction results and source reports that some at the BoJ were said to see a need for future normalization talks, failed to garner a reaction, as they also agreed that current stimulus was needed for the time-being.

Top Asian News

  • Some at BOJ Are Said to Flag Need for Future Normalization Talks
  • Pimco, Goldman Asset See China as Threat to Emerging Bonds
  • Celebrity Eye Clinic Quintuples in Four Days After Hong Kong IPO
  • Battle of K-Pop Stocks: ‘Twice’ Girl Group Agency Now No. 2
  • India Steel Ministry Seeks Abolition of Met Coal Import Tax
  • ‘Terminator’ Lourenco Proves He’s No One’s Puppet in Angola
  • China Banks Boost H-Share Gains as GDP Growth Comes in Strong

European equities are inching higher this morning following on from the bounce back seen on Wall Street, which had stemmed from reports that Apple are to pledge a USD 350bln contribution to the US economy. Additionally, optimism over a potential passing of a stop-gap funding bill to prevent a government shutdown also buoyed demand for equities. Elsewhere, encouraging Chinese GDP data helped aid sentiment with China reporting the fastest growth in 2yrs. IT names outperforming in Europe with Infineon shares rising some 4% after a positive note out from Goldman Sachs. FTSE 100 struggling thus with the index dragged down by the likes of Whitbread after a soft earnings report. Meanwhile, more downside pressure in the debt markets, and US Treasury led as the 10 year benchmark yield inches another basis point closer to the 2.63-64% area that many chartists and cash traders have been flagging if not targeting. Bunds have now been down to 160.32, -1/2 point on the day and just 2 ticks shy of tech support that stands in front of the January low so far at 160.11. Accordingly, 10 year German yields are within a whisker of 0.6%, albeit on the relatively new 2028 bond.

Top European News

  • BP Signs Iraq Deal to Help Increase Oil Output at Kirkuk Fields
  • Weidmann’s Fiscal Ideas May Cap German Yields
  • Countrywide Tumbles on Warning; Foxtons, Rightmove Also Drop
  • UBS Rises; Credit Suisse Sees UHNW Boost, Says Buyback Likely

In FX, the USD Index extended recovery gains to just over 91.000 overnight, but quickly backed off again despite supportive impulses via data, rising Treasury yields and another solid Fed Beige Book. The Greenback is now relatively mixed within ranges vs G10 counterparts, around 1.2200 against the Eur, 111.25 vs the Jpy and with Cable back down between 1.3800-50 after a spike to 1.3942 (new peak since the Brexit vote). Back to Usd/Jpy, and some large option expiries could well provide some direction today, with 1.4 bn at the 111.00 strike and 1.5 bn at 110.80, while on the upside there is key chart resistance at 111.74 (200 DMA) and 111.97 (50% Fib). For Eur/Usd, if 1.2200 is breached again on the downside then stops are reportedly seen below 1.2150, while 1.2119 is tech support ahead of the next big figure. Aud and Nzd both firming up again vs their US counterpart towards 0.8000 and 0.7300 after the former traded in a volatile fashion on mixed jobs data. In terms of crosses, Eur/Gbp has seen offers around 0.8830 filled, but bids at 0.8800 and strong chart support around 0.8792 are forming a base.

In commodities, WTI and Brent crude futures marginally lower despite last nights wider than expected drawdown in the latest API crude report. Price action in oil largely dictated by the mild recovery seen in the USD-index. Saudi Aramco is to boost refining capacity to 8mln-10mln bpd from 5mln bpd. US API weekly crude stocks (12 Jan, w/e) -5.120M vs. Exp. -3.500M (Prev. -11.190M).

Looking at the day ahead, there’s no data due in Europe, however the Bundesbank’s Weidmann and ECB’s Coeure are due to speak at a joint conference with the IMF in Frankfurt. In the US, December housing starts and building permits are due along with the January Philly Fed business outlook and latest weekly initial jobless claims numbers. Morgan Stanley is due to report Q4 earnings, along with IBM and American Express.

US Event Calendar

  • 8:30am: Housing Starts, est. 1.27m, prior 1.3m;
  • 8:30am: Building Permits, est. 1.3m, prior 1.3m
  • 8:30am: Philadelphia Fed Business Outlook, est. 25, prior 26.2
  • 8:30am: Initial Jobless Claims, est. 249,000, prior 261,000; Continuing Claims, est. 1.9m, prior 1.87m
  • 9:45am: Bloomberg Economic Expectations, prior 47; Consumer Comfort, prior 53.5

DB's Jim Reid concludes the overnight wrap

The only train running last night was the bulled up express with the S&P 500, Dow and Nasdaq up +0.94%, +1.25% and 1.03% respectively - their best day since late November for the first two and 2nd January for the Nasdaq. Within the S&P, all sectors were up with gains led by the tech, energy and consumer staples stocks. Apple’s share price rose 1.65% after announcing it will repatriate some of its offshore cash reserves, with plans to spend $30bn on capex in the US over the next five years, even after paying $38bn of taxes. Elsewhere, reactions to corporate earnings were a little mixed, Bank of America’s 4Q result was above market but the share price dipped 0.19%, following a c36% rally since mid-September, while Goldman Sachs fell 1.86% after its annual fixed income trading revenue fell to the lowest since the GFC.

Staying with US tax cuts and economic growth, the Fed’s Mester noted the risks are still balanced, but in terms of her estimates for the impact from fiscal policy, she thinks “there are some salient upside risks”, although this will be guided by how firms and households react in their spending. Elsewhere, the Fed’s Evans noted the US economy is strong and tax cuts “should add to business investments”. Our US team noted that if these fiscal changes only provide demand-side stimulus, they could quicken the arrival of the next recession by pulling forward demand and causing the Fed to move more aggressively on rate hikes. Refer to their note for a detailed assessment of how tax reform will impact the economy in 2018 and beyond.

Turning to Fed speak on inflation, the Fed’s Evans said “I’m confident we are going to be on a path” to the 2% target, although the Fed’s Kaplan believes that while “inflation pressures are building…they are being offset to a great degree by technology enabled disruption”. On the rates outlook, Ms Mester noted “a gradual pace of interest increase over the course of this year will be appropriate” and that she is “not concerned” the US is nearing a recession. Mr Evans reiterated his dovish view and noted that “something less than three (hikes) is probably appropriate” and it’s better to wait till June where if growth and inflation readings are robust, then “we would have time for three hikes in the year”. Conversely, the Fed’s Kaplan doesn’t want to get in a situation where the cyclical inflationary forces are getting stronger “….to the point where the Fed feels it needs to move much more rapidly to address it”, so the Fed   should be “acting sooner rather than later” on rates.

In China, its 4Q17 GDP stats (6.7% expected), retail sales and IP are expected to be out just after we go to print at 7am UK time. Ahead of the data dump, our China economists have published a timely presentation outlining their  views on China’s opportunities and risks in 2018-2020. Amongst the key messages, they believe the tightening of fiscal policy is the most underestimated risk in 2018, in part as fiscal spending was a key driving force behind the  economic cycle in 2014-17. So growth is set to slow in 2018. Further, the team is more worried about inflation than consensus. Refer to their report for more details.

This morning in Asia, markets pared gains to be modestly lower, with the Nikkei (-0.1%), Kospi (-0.05%) and Hang Seng (-0.02%) all modestly down. Elsewhere, Bloomberg reported a minority within the BOJ are raising the need to  eventually start to discuss policy normalisation – as per unnamed sources.

Now recapping other markets performance from yesterday. European equities weakened with the Stoxx 600 down 0.10%, weighed down by telco and health care stocks. Across the region, key bourses fell c0.4% (CAC -0.36%; FTSE -0.39%; DAX -0.47%) while Italy’s FTSEMIB rose marginally. Core European 10y bond yields were little changed (Bunds +0.1bp; Gilts +0.4bp) but UST 10y rose 5.2bp, partly weighed down by concerns of a potential government  shutdown, increasing US bond supply (partly on concessions to get a deal done) and US Treasury Department’s data showing China’s holding of Treasuries fell to a four month low in November (-1.1% mom to $1.18trn). This morning, UST 10y is c0.6bp lower.

Turning to currencies, the US dollar index rebounded slightly (+0.16%) from its three year low, while Euro dropped 0.60% post the various ECB speak (more below). Sterling jumped to an intraday high of 1.394 before stabilising to end the day 0.28% higher – a fresh post Brexit high. In commodities, WTI oil rose 0.38%, partly reflecting solid compliance to OPEC production cuts, which was 125% in December. Elsewhere, precious metals weakened (Gold  -0.86%; Silver -1.12%) and other base metals also fell, but losses are moderating (Copper -0.54%; Zinc -0.36%; Aluminium -0.17%).

Away from the markets and onto other central bankers commentaries. There appears to be more jawboning on the stronger Euro, with the ECB’s Nowotny noting the recent strength is “not helping” and must be observed. Further, the ECB’s Constancio noted “I’m concerned about sudden movements” in the exchange rate “which don’t reflect changes in fundamentals” and that looking at the fundamentals “inflation declined slightly in December”. Elsewhere on policy guidance, he noted that while we see the need for a gradual adjustment of all the elements of our forward guidance, “this does not mean that changes will be immediate”.

Continuing with the theme of ECB’s guidance, DB’s Mark Wall argues that given the strength of the Euro economy, relatively easy and stable financial conditions (despite recent market moves), he expects a change to forward guidance within the next few months. The team has set out a base time line for this change, including: i) At the press conference on 25 January, they expect Mr Draghi to prepare the ground for changes to forward guidance. ii) In March/April, they expect the ECB to redefine the reaction function within forward guidance, weakening the direct link between economic/financial shocks and QE. iii) In June, they expect the ECB to announce a tapering of QE net purchases to zero over the course of Q4 and finally iv) In Q4 they expect the ECB to adjust rates guidance to manage expectations for the timing and pace of policy rate hikes in 2019. Overall, we see the less hawkish strategy as being more likely, but one way or another, exit is in train.

Back in the UK, the BOE’s Saunders reiterated his slightly hawkish stance, noting that the unemployment rate could drop below 4% in 2018 and that with “….labour market tightness and signs of higher growth…(then) I consider it likely  that interest rates will need to rise further over time”. Elsewhere, on Brexit, the EU side have continued to offer reassuring rhetoric if the UK changes its mind on Brexit. Yesterday, the Head of the EU executive arm noted the UK can always re-apply for EU membership after departing. Conversely, PM May’s spokesman responded “we have been absolutely clear…that we are leaving the EU….I’m not sure how much clearer we can be”.

Before we take a look at today’s calendar, we wrap up with other data releases from yesterday. In the US, the December IP was above market expectations at 0.9% mom (vs. 0.5%), although the prior month was revised down by 0.3ppt. In the details, most of the growth in December was due to a 5.7% mom increase in utility production and a 1.6% mom increase in mining production. Elsewhere, capacity utilisation also beat at 77.9% (vs. 77.3%) while the January NAHB housing market index was in line at 72, following a 5pt improvement to a 17- year high back in December. Finally, the Fed’s latest Beige book painted an upbeat picture. It noted 11 Districts reported “modest to moderate gains” in activity and Dallas reported a “robust” increase. Further, the outlook for this year remains optimistic for a majority of the Fed’s contacts across the country.

Most Districts cited on-going labour market tightness and most Districts said that wages increased at a “modest” pace.

In Europe, the final December reading for the Euro area CPI was unrevised, with headline CPI at 1.4% yoy and core CPI at 0.9% yoy, which was steady for the third consecutive month.

In Canada, the central bank lifted the cash rate by 25bp to 1.25% as widely expected. Looking ahead, the BOC seems a bit dovish and noted that “while the economic outlook is expected to warrant higher interest rates over time...... some continued monetary policy accommodation will likely be needed…. (and) the Governing Council will remain cautious in considering future policy adjustments”. The Bank also pointed to uncertainty surrounding the future of the North American Free Trade Agreement (NAFTA).

Looking at the day ahead, there’s no data due in Europe, however the Bundesbank’s Weidmann and ECB’s Coeure are due to speak at a joint conference with the IMF in Frankfurt. In the US, December housing starts and building permits are due along with the January Philly Fed business outlook and latest weekly initial jobless claims numbers. Morgan Stanley is due to report Q4 earnings, along with IBM and American Express.