Ten-year US Treasury bond yields surged to a four-month high of 3.94 per cent on Wednesday (5 July), rising by as much as 10 bps.
NAB currency strategist Rodrigo Catril has described the yield boost as a “bear steepening”, with markets increasingly bracing for a longer-than-anticipated battle against inflation.
Projections of further monetary policy tightening from the world’s central banks, particularly the Federal Reserve, prompted a sharp sell-off of long-term Treasury bonds.
This coincided with the release of minutes from the latest Federal Open Market Committee (FOMC) meeting, which revealed a group of members needed to be convinced to support a pause to the tightening cycle.
Treasury bond yields have consolidated ground following a sharp slide during the height of the COVID-19 pandemic, triggered by aggressive cuts to interest rates.
Yields on 10-year US Treasury bonds hit as low as 0.6 per cent, before a rapid rise following the commencement of monetary policy tightening.
Wednesday’s rally spurred the sharpest increase in 10-year Australian government bond yields in almost a decade, opening on Thursday (6 July) at 3.78 per cent.
Equity markets save FY23 but set to dip
The resurgent bond market is helping to offset equity market volatility amid mounting uncertainty over the macroeconomic outlook.
Shares rallied in the early part of 2023, helping to drive returns over the 2022–23 financial year (FY23).
Global shares gained 23 per cent (in AUD currency terms), while Australian shares rose 15 per cent.
The rally came amid hopes of earlier-than-expected inflation relief and a soft economic landing, since crushed by banking stress in the United States and Europe, as well as evidence of inflation stickiness.
According to AMP Capital chief economist Shane Oliver, the FY23 boost overshot, with a setback likely as economic conditions deteriorate.
“The bad news is that the risk of a near correction in shares is high,” he observed.
“Shares had strong gains in June and are now overbought technically. Leading economic indicators continue to point to a high risk of recession in the US and the risk of recession in Australia is now around 50 per cent.
“China’s recovery is looking less robust than expected and policy stimulus there so far has been pretty modest.”
Moreover, “hawkish” central banks risk going “too far” with their monetary policy tightening cycles.
This, Mr Oliver added, would be exacerbated by geopolitical tensions, particularly the ongoing conflict in Ukraine.
These headwinds would be underpinned by a seasonal dip in demand for shares over the coming months.
Over the medium term, disinflation and weaker economic conditions would pave the way for monetary policy easing and could revive a floundering economy.
“In Australia, we expect the RBA’s cash rate to peak around 4.6 per cent with four rate cuts through 2024,” Mr Oliver observed.
He said the global economy has also proven more resilient than investors had feared, supporting expectations for a mild downturn in aggregate economic activity.
“So, while shares are vulnerable to a near term correction, returns over the next 12 months should still be reasonable albeit slower than they have been over the last 12 months,” he said.
“At the same time, bond returns should be positive as bond yields settle down with falling inflation.”
