July’s bull market for U.S. and global stocks appeared to end last week, with the S&P 500 down 2.3% last week and the NASDAQ down 3.2%. The FTSE 100 fell 4.2%, while the Euro Stoxx 50 was down 3.6%.
At the risk of over-simplification, the clearest explanation appears to be a steady rise in global bond yields over much of last week, that included Treasuries, gilts, bonds and Japanese Government Bonds (JGBs).
Higher ‘risk free’ yields increase the relative attraction of risk-free assets, such as government bonds, over equities and other risk assets. They also reinforce the ‘higher for longer’ interest rate theme, which could reduce profits growth expectations for stock market investors.
Note, however, that bond yields fell on Friday, in response to July labour market that is best described as ambiguous.* New non-farm payroll growth was weaker than expected, at 180,000, but the fall in the unemployment level to 3.5%, and 4.4% annual hourly pay growth, suggests a still-tight labour market.
So why did bond yields rise for most of last week?
The global rise in bond yields wasn’t caused by the recent rate hikes from the Fed, ECB and, last week, from the Bank of England. These were in line with expectations and the accompanying statements on the outlook for inflation and interest rate policy were unsurprising. It appears increasingly likely that central banks are close to peak interest rates (and perhaps at that point in the U.S.), thanks to falls in previously stubborn core inflation.
Rather, the increase in bond yields has been attributed to two very different surprises.
First, from the rating agency Fitch, which last Tuesday downgraded U.S. government debt, from AAA to AA+.** This followed the downgrade by Standard and Poor in 2011. Fitch cited both debt and ‘governance’ i.e., political, reasons.
Since no country that prints its own money need default on local currency debt, Fitch’s downgrade may have had less impact had it not coincided with an unfortunately timed announcement from the Treasury. It announced an increase in the amount of long-dated Treasuries issued this year, due the growing gap between tax receipts and government expenditure, appearing to confirm any fears raised by the Fitch announcement on over-supply.
Bank of Japan
Second, the Bank of Japan. The BoJ ten days ago eased its yield curve control (YCC) policy. It raised the maximum yield on the 10yr JGB that will be permitted before it intervenes, from 0.5% to 1.0%.*** The 10 yr. yield climbed 20bp, in response, and is currently at a seven-year high of 0.63%.
The still-low yields on JGBs make them unattractive to many global investors. After all, the 10yr Treasury is yielding 4.1%, and the 10yr U.K gilt 4.8%. But not necessarily to Japanese investors, who fear that even small rises in JGB yields could lead to an appreciating yen and to currency losses on overseas investments (as the cost of hedging the yen rises).
An appreciating yen might then encourage more selling of overseas investments, not just bonds. This cycle could feed on itself, with prices for financial assets elsewhere falling in response.
Japan was the largest foreign holder of Treasuries at the end of 2022 (followed by China), and in the first quarter of this year Japan bought more Treasuries than in any previous quarter, worth $68 billion worth. An exodus of Japanese investors could have major repercussions on Treasury prices, with yields likely to rise.
Of course, the Bank of Japan is nervous of slipping back into deflation -which it has battled against for nearly 30 years- and may intervene to stop an appreciating yen, and higher borrowing costs. This might trigger a return of deflation. It could prevent this by reducing the YCC policy rate, i.e., reversing the recent increases in the intervention yield target. But this would be politically difficult, with savers and consumers unsettled by the country’s 3.3% CPI inflation. The BoJ is treading a very fine line.
Investors should play the U.S. and global soft landing elsewhere
The soft-landing scenario for the U.S., and indeed the global economy, appears intact. There was nothing substantive last week that might challenge this broadly optimistic scenario.
However, and as we have written before, this does not mean U.S. stocks would be the best play on a U.S. and global economic recovery next year. Valuation arguments suggest European and Asian cyclical stocks over U.S. tech. Meanwhile, growing positive real yields on Treasuries and dollar cash offer investors a risk-free return that may be difficult to ignore.
Bank of England
On Thursday the Bank of England raised its key rate to 5.25%, as expected and left the door open for a further hike.**** At $1.27, it is unchanged over the week. It warned that interest rates are likely to ‘remain elevated’.
While it acknowledged that inflation is falling (it is currently the highest of any G7 country, at 7.9%), it said that progress bringing it down to the 2% target will be delayed because of persistent labour shortages and high energy costs. The Bank does not expect its inflation target to be reached until mid-2025.
The good news is that first, the Bank no longer expects a recession. This follows a similar improved forecast from the IMF the previous week. Second, mortgage rates appear to have peaked, with fixed term rates now starting to fall.
At Brite Advisors USA, we work with UK ex-pats all over the USA on their investment needs, both retirement and non-retirement. Our US-based advisory team seeks to provide an outstanding experience for all clients.
We facilitate UK pension transfers using UK Self-Invested Personal Pension Plans (“SIPP”) provided by UK-regulated pension trustees for clients who want to save for their retirement by taking advantage of potential stock market growth.
No Investment Advice: This brochure is for informational purposes only and is not intended to be, and should not be, construed as an offer to sell or a solicitation of an offer to buy any security or financial instrument or invest in any equity or investment strategy. It should not be used to form the basis of any investment decision.
Investment Risks: There are risks associated with investing in securities and past performance is not indicative of future results. Always seek professional advice before investing. Investment suitability must be determined individually for each investor and any financial instruments/strategies described in this brochure may not be suitable for all investors.
Not Legal/Tax Advice: This brochure is not intended to be, and should not be construed as, legal, regulatory, tax, or accounting advice. Always seek professional advice and consult with your legal counsel, tax and accounting advisors when contemplating any course of action.
Third-Party Websites: This brochure may contain or reference links to websites operated by third-parties. These links are provided as a convenience only. Such third-party websites are not under the control of Brite USA and Brite USA is not responsible for the content of any third-party website or any link contained in a third- party website. Brite USA does not review, approve, monitor, endorse, warrant, or make any representations with respect to third- party websites. Brite USA is not responsible for the information contained in such third-party websites or for your use of such third-party websites. Access to any third-party websites is at your own risk.
Brite USA does not provide tax advice. To the extent this brochure mentions or references any tax matter, it is not intended or written to be used, and cannot be used by the recipient or any other person, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party the matter addressed herein. Please consult an independent tax advisor for advice on your particular circumstances.
Discover the pros and cons of timing the market vs. time spent in the market. Explore the emotional challenges, risk factors, and potential returns of these investment strategies to make informed financial decisions.
Each of the stock market sectors have companies worth looking at. In this article we highlight some of the most promising companies in each of these 11 sectors that could potentially provide investors
Each of the stock market sectors have companies worth looking at. In this article we highlight some of the most promising companies in each of these 11 sectors that could potentially provide investors
Taking Stock: higher bond yields spread unease
July’s bull market for U.S. and global stocks appeared to end last week, with the S&P 500 down 2.3% last week and the NASDAQ down 3.2%. The FTSE 100 fell 4.2%, while the Euro Stoxx 50 was down 3.6%.
At the risk of over-simplification, the clearest explanation appears to be a steady rise in global bond yields over much of last week, that included Treasuries, gilts, bonds and Japanese Government Bonds (JGBs).
Higher ‘risk free’ yields increase the relative attraction of risk-free assets, such as government bonds, over equities and other risk assets. They also reinforce the ‘higher for longer’ interest rate theme, which could reduce profits growth expectations for stock market investors.
Note, however, that bond yields fell on Friday, in response to July labour market that is best described as ambiguous.* New non-farm payroll growth was weaker than expected, at 180,000, but the fall in the unemployment level to 3.5%, and 4.4% annual hourly pay growth, suggests a still-tight labour market.
So why did bond yields rise for most of last week?
The global rise in bond yields wasn’t caused by the recent rate hikes from the Fed, ECB and, last week, from the Bank of England. These were in line with expectations and the accompanying statements on the outlook for inflation and interest rate policy were unsurprising. It appears increasingly likely that central banks are close to peak interest rates (and perhaps at that point in the U.S.), thanks to falls in previously stubborn core inflation.
Rather, the increase in bond yields has been attributed to two very different surprises.
First, from the rating agency Fitch, which last Tuesday downgraded U.S. government debt, from AAA to AA+.** This followed the downgrade by Standard and Poor in 2011. Fitch cited both debt and ‘governance’ i.e., political, reasons.
Since no country that prints its own money need default on local currency debt, Fitch’s downgrade may have had less impact had it not coincided with an unfortunately timed announcement from the Treasury. It announced an increase in the amount of long-dated Treasuries issued this year, due the growing gap between tax receipts and government expenditure, appearing to confirm any fears raised by the Fitch announcement on over-supply.
Bank of Japan
Second, the Bank of Japan. The BoJ ten days ago eased its yield curve control (YCC) policy. It raised the maximum yield on the 10yr JGB that will be permitted before it intervenes, from 0.5% to 1.0%.*** The 10 yr. yield climbed 20bp, in response, and is currently at a seven-year high of 0.63%.
The still-low yields on JGBs make them unattractive to many global investors. After all, the 10yr Treasury is yielding 4.1%, and the 10yr U.K gilt 4.8%. But not necessarily to Japanese investors, who fear that even small rises in JGB yields could lead to an appreciating yen and to currency losses on overseas investments (as the cost of hedging the yen rises).
An appreciating yen might then encourage more selling of overseas investments, not just bonds. This cycle could feed on itself, with prices for financial assets elsewhere falling in response.
Japan was the largest foreign holder of Treasuries at the end of 2022 (followed by China), and in the first quarter of this year Japan bought more Treasuries than in any previous quarter, worth $68 billion worth. An exodus of Japanese investors could have major repercussions on Treasury prices, with yields likely to rise.
Of course, the Bank of Japan is nervous of slipping back into deflation -which it has battled against for nearly 30 years- and may intervene to stop an appreciating yen, and higher borrowing costs. This might trigger a return of deflation. It could prevent this by reducing the YCC policy rate, i.e., reversing the recent increases in the intervention yield target. But this would be politically difficult, with savers and consumers unsettled by the country’s 3.3% CPI inflation. The BoJ is treading a very fine line.
Investors should play the U.S. and global soft landing elsewhere
The soft-landing scenario for the U.S., and indeed the global economy, appears intact. There was nothing substantive last week that might challenge this broadly optimistic scenario.
However, and as we have written before, this does not mean U.S. stocks would be the best play on a U.S. and global economic recovery next year. Valuation arguments suggest European and Asian cyclical stocks over U.S. tech. Meanwhile, growing positive real yields on Treasuries and dollar cash offer investors a risk-free return that may be difficult to ignore.
Bank of England
On Thursday the Bank of England raised its key rate to 5.25%, as expected and left the door open for a further hike.**** At $1.27, it is unchanged over the week. It warned that interest rates are likely to ‘remain elevated’.
While it acknowledged that inflation is falling (it is currently the highest of any G7 country, at 7.9%), it said that progress bringing it down to the 2% target will be delayed because of persistent labour shortages and high energy costs. The Bank does not expect its inflation target to be reached until mid-2025.
The good news is that first, the Bank no longer expects a recession. This follows a similar improved forecast from the IMF the previous week. Second, mortgage rates appear to have peaked, with fixed term rates now starting to fall.
Sources:
* https://www.bls.gov/news.release/empsit.nr0.htm
** https://www.fitchratings.com/research/sovereigns/fitch-downgrades-united-states-long-term-ratings-to-aa-from-aaa-outlook-stable-01-08-2023
*** https://asia.nikkei.com/Economy/Bank-of-Japan/Japan-s-10-year-bond-yields-reach-9-year-high-on-BOJ-policy-changes
**** https://www.bankofengland.co.uk/explainers/why-are-interest-rates-in-the-uk-going-up
Ready to find out more?
At Brite Advisors USA, we work with UK ex-pats all over the USA on their investment needs, both retirement and non-retirement. Our US-based advisory team seeks to provide an outstanding experience for all clients.
We facilitate UK pension transfers using UK Self-Invested Personal Pension Plans (“SIPP”) provided by UK-regulated pension trustees for clients who want to save for their retirement by taking advantage of potential stock market growth.
Contact us today to find out more.
Disclosures:
Recent posts
Timing the Market vs. Time Spent in the Market: An Analysis
Discover the pros and cons of timing the market vs. time spent in the market. Explore the emotional challenges, risk factors, and potential returns of these investment strategies to make informed financial decisions.
Taking Stock: the Fed versus the Black Knight
Each of the stock market sectors have companies worth looking at. In this article we highlight some of the most promising companies in each of these 11 sectors that could potentially provide investors
Taking Stock: The Middle East & the soft-landing conundrums
Each of the stock market sectors have companies worth looking at. In this article we highlight some of the most promising companies in each of these 11 sectors that could potentially provide investors