To what extent can rising bond yields affect the market?

WILL Goldman Sachs’ stress test for US 10-year Treasury yields, which spiked on inflation worries, to hit 4.5% come true?

“Definitely impossible. I do not foresee runaway inflation or systemic financial risk to create such an environment,” said Vincent Khoo, head of research, UOB Kay Hian.

“This scenario is possible if US inflation, with the rise in wages, approach the Fed’s comfort zone of 2%. If prices rise more rapidly, forcing the Fed to raise rates higher and faster than expected, it can cause the stockmarket to crash,” said Lee Heng Guie, executive director, Socio Economic Research Centre.

Goldman’s base-case scenario calls for a 10-year yield of 3.25% by year end, though a “stress test” to 4.5% indicates that such a move would cause stocks to tumble, economist Daan Struyven was quoted by Bloomberg as saying.

The benchmark 10-year note had recently gone to a four-year high of 2.957%. Last Friday, it slipped to 2.81%. “A repricing of risk could set in if there are surprises, given that stock prices are high relative to earnings. Investors also worry about the US twin deficits (fiscal and current account deficits) that can cause long term rates to rise,” said Lee.

Will the Fed reinstate its quantitative easing (QE – buying of bonds to support markets) from which it is withdrawing?

“Before that (bond yields hitting 4.5%) happens, I believe the Fed will reinstate its QE programme,” said Pong Teng Siew, head of research, Inter-Pacific Securities.(Chiefs of Fed subsidiaries in New York and Boston, Bill Dudley and Eric Rosengren, had indicated at a panel that bond purchases may be necessary again).

“The return of QE is not expected but the Fed may reduce its balance sheet at a slower rate. That had dropped by around US$37bil between October 2017 and January 2018 – the plan was to cut it by US$60bil in the same period.

“This suggests that the Fed’s ability to reduce its balance sheet, to some extent, is affected by the US fiscal stimulus as it cannot exit QE too aggressively,” said Suhaimi Ilias, group chief economist, Maybank Investment Bank. It could be a stuation of being trapped between the “devil and the deep blue sea.”

“Keeping to its present course (of QE withdrawal) means an end to the expansion cycle, which may be earlier than the trajectory I envisaged, that is, a recession by end-2019. An end to the bull market on Wall Street will mean trillions in paper wealth destroyed if asset prices implode. The Fed’s exit as the biggest buyer of Treasuries at the margin will coincide with a deluge of issuances. This amounts to a need to absorb possibly an additional US$1.8 trillion in Treasuries in the next 12 to 18 months.

“How is the financial market going to absorb that?” asked Pong.

On the other hand, reverting to QE means that an endless cycle of QEs may become necessary.

“It will be a tough balancing act for the Fed to calibrate monetary tightening without hurting economic expansion since the 2008 crisis and keep the risk of inflation at bay,” said Lee.

“If a faster programme of rate hikes had been introduced earlier, there may be less of a total increase in rates and the expansion cycle need not go through sharp swings of boom and bust. Unsustainably low rates kept the US Government under the impression that they can borrow larger sums of money. A period of painful adjustment may now be forced upon the economy,” said Pong.

How will this impact Asian markets?

“If the US Government is forced by markets to back away from its spending plans, the problem will come to haunt Asia through slower growth and fall in trade.

“It will also precipitate a loss of confidence especially through the financial market reaction,” said Pong.

Saudi Arabia hopes the Organisation of Petroleum Exporting Countries (Opec) and its allies can relax output cuts next year and create a framework to stabilise oil markets.

“Both Opec and non-Opec members must be committed to implement the framework to pre-empt supply and demand shocks. It must also be governed in a transparent manner,” said Lee.

President Donald Trump’s move to slap tariffs on steel and aluminium imports will likely undermine the prospects of global trade, and fuel concerns of an ugly trade war.

“Malaysia exports about 96,000 tonnes of steel to the United States, which is small compared with US imports of 30 million tonnes. China, the world’s largest producer of steel and aluminium, accounted for 2.9% of US imports; its exports of aluminium to the United States make up 14% of total shipments,” said Lee.

Columnist Yap Leng Kuen prays for stability.