Was it just a transitory bout of angst? Or have we finally witnessed the end of the great 32-year bull market in bonds?
It feels to me like the latter with yields on 10-year and 30-year US Treasuries up by half a percentage point since the start of May and emerging markets in a funk. We are in such uncertain monetary territory that anything could yet happen to upset that judgment. What is clear is that the rules of the global market game have changed in a remarkably short space of time.
This is most visible in currency markets where the absurdity of risk-on, risk-off trading appears to be coming to an end.
Since the financial crisis there has been a tendency for traders to move into emerging market and commodity currencies and into equities in the risk-on phase where central banks succeeded in persuading investors to assume more risk. In risk-off mode they moved back into the dollar which enjoyed haven status because of its pre-eminent reserve currency role and its solid underpinning by highly liquid markets.
In the turmoil of recent weeks the dollar has been strengthening on good news – the opposite of its recent risk-on behaviour. At the same time emerging market currencies have ceased to be a vehicle for providing generalised risk-on exposure to financial markets, while emerging equities have underperformed developed world equities.
The change is particularly apparent for commodity currencies, which now more realistically reflect the unwinding of the resource boom and the likely decline in the resource-intensity of growth in China as the balance of the economy shifts from exports and investment to consumption. For countries such as Australia, which has seen phenomenal growth for the best part of two decades, it makes sense to allow the Australian dollar to take some of the strain of this adjustment.
Among the biggest fallers has been the South African rand, reflecting the fall in the gold price. This is partly related to movements in the US bond market, because the rise in Treasury yields means the opportunity cost of holding gold, which produces no income, is rising. Tightening US liquidity is traditionally bearish for the yellow metal.
And then there is Japan, where the recent plunge in the equity market was accompanied by an appreciation of the yen amounting to almost 9 per cent in just three weeks. The relief across the rest of Asia has been palpable. That, too, amounted to a notable change in market behaviour. Throughout Japan’s 23-year economic and financial crisis there has been little financial linkage with the rest of the world and minimal contagious fallout. Yet it was the announcement of the big proposed increase in the Bank of Japan’s asset purchases in April that provided the trigger for the recent turmoil in the markets.
The good news about the new rules of the game is that markets are beginning to differentiate more carefully between countries and assets on the basis of fundamental analysis, which is a vast improvement on knee-jerk risk-on, risk-off behaviour.
The less good news is that the eurozone still hangs like a dark cloud over the global economy, in recession with no comprehensive solution in sight to the problem of imbalances and a banking system that is undercapitalised and overloaded with sovereign debt. It is curious that the euro strengthened against the dollar in the recent turmoil. A reckoning may be around the corner.
Yet the US is also a potent source of uncertainty, because of the great tapering debate, relating to whether and when the Federal Reserve will retreat from quantitative easing. As Stephen Lewis of Monument Securities remarks, the fear that the Fed will not taper, or indeed dare not taper, may be as significant a factor in the current malaise as anxiety that it will. The market, he adds, has realised it is difficult to write a happy ending to this story.
Too darn right.
The writer is an FT columnist