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Mizuho daily market insights by Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,
Between Rotation & Risk Aversion
A glace across Wall St, where Nasdaq suffered a heavy sell-off (-2.4%) with S&P500 slipping 0.5% but Dow surged 1.0%, suggests that the theme is one of rotation (out of tech into cyclicals and industrials); rather than indiscriminate “risk off”. Perhaps so; especially with futures up. But in these noisy markets, identifying motivation is more helpful than characterization. And that is where unrelentingly higher UST yields (30Y past 2.3%, 10Y hitting 1.6%, 5Y at 0.85% and 2Y above 0.16%) appear to be the culprit demanding a re-assessment of valuations.
Specifically, nominal 10Y UST yields back at Feb 2020 levels of ~1.6% and real (10Y) yields jumping above -0.7% (back to mid-2020) levels may be motivating unbridled “everything rally” from cheap money to evolve into differentiated picks for reflation bets hinged on optimism.
Meanwhile, signs inflation expectations exhausting earlier front-running of nominal yields is accentuating pick-up in real UST yields and consequently USD; knocking EUR below mid-1.18; pressuring AUD ~mid-0.76; lifting USD/JPY above 109, and; USD/SGD following suit above 1.35. But even within commodity and EM currencies there appears to be some degree of rotation, as oil currencies outside of Asia hold up better and higher-yielding EM Asia FX spared the worst.
Why UST Yield Ripples Won’t Stop at EM Low-Yielders
The sharp rise in UST yields (to 1.6%) appears to have hurt low-yielding EM Asia currencies worse; although not exclusively so. To be sure, a stronger USD coinciding (if not caused by) a surge in UST yields tends to knock back most EM Asia FX across the board.
Nonetheless, the relative under-performance of low-yielding currencies such as THB and KRW compared to higher-yielding (and ordinarily higher volatility) currencies such as the IDR and INR is counter-intuitive. In fact it is downright bewildering. For instance KRW and THB have tumbled 1.1% and 0.7% since Friday; a far sharper correction compared to a 0.3% and 0.4% pullback for INR and IDR. And on the week, INR is 0.4% stronger while IDR fell a more measured 0.7% compared to the 1.9% drop in THB and 0.9% KRW slide.
Right off the bat, this is counter-intuitive insofar that a coincident surge in Oil ought to hurt INR and IDR most; given deeply entrenched vulnerabilities. But yield dynamics are blamed. This is mostly being explained off as the ultra thin spreads between low-yielding EM Asia currencies and USTs resulting in the most sensitive sympathetic sell-off in low-yielders. Whereas, higher-yielding EM Asia currencies are perceived less vulnerable given the allure of wider (EM-UST) yield spreads.
In other words, markets are simultaneously engaged in;
i. risk re-pricing for low-yielders (which now have a much thinner insulation) and;
ii. yield-seeking in higher-yielding currencies to compensate for pick-up forgone in lower-yielding EM.
But this should not be mistaken for a case of high-yield assets being impervious. Rather it ought to be appreciated as a discontinuous process of risk re-pricing.
Contrary to the efficient markets theory, there are kinks in initial price signals due to conflicting motivations. The wider point is that sustained rise in UST yields will spillover to knock back higher-yielding EM currencies; once broader risk re-pricing catches up with initial yield seeking. Especially with a steeper yield curve poised to undermine FX with “twin deficits” and higher inflation exposures as risk-adjusted, real returns factor into sustained risk re-pricing. Upshot being, prospects of higher UST yields and a disproportionately steeper yield curve are setting the stage for a catch-down in higher yielding EM Asia currencies. After all, another take on “rotation” is, “what goes around, comes around”.
Credit Source: Mizuho Bank Ltd
