As global yields rise, expect reversals in other trends - AmpGFX

Greg Gibbs, Director at Amplifying Global FX Capital, suggests that we can see further rises in global yields unwinding an extreme low that evolved on expectations of more QE, deeper negative rates, and extreme disinflationary expectations. 

Key Quotes

“This has distracted the market from the evidence of modest improvement in the global economy and a rising trend in commodity prices this year.  Brexit and more bearish long-term forecasts by the Fed since mid-year further dampened yields, but on both fronts, pessimism may be overdone.

If yields were to continue to rise, then we might look for the potential impacts on other markets.  Diminishing yields have seen investors run toward higher yielders such as the NZD this year.  Falling inflation expectations and fear related to Brexit, weak banking sector performance, political risks and diminishing central bank credibility appeared to boost the JPY and EUR.  The strength in these currencies themselves generated a vicious cycle, further undermining inflation expectations and central bank credibility.

We see gains in JPY continuing to unwind as yields rise.  Global investors will also note that higher global yields will tend to improve the USD/JPY yield advantage, as BoJ QE/NIRP/YCC will ensure any rise in Japanese yields is dampened.

EUR has been relatively stable this year, boosted by risk aversion related to Brexit, weak European bank performance and political uncertainty in Italy and several other European countries, and diminishing perceptions of the effectiveness of the ECB’s NIRP/QE policy.  On the other hand, EUR has been dampened by the fundamental risks to the European economy related to all the same things.

In the end, we see the fundamental risks to the European economy taking over.  As global yields rise, inflation expectations firm and Brexit becomes more fully priced, we see risk aversion that has tended to support EUR diminishing, allowing space for EUR to weaken.

The EUR/USD may yet be dragged back by a weaker GBP/USD, and the recent improvement in the USD yield advantage over EUR.

While risk aversion and falling global yields tended to support the ultra-low yielders (JPY, EUR, and gold), they also tended to support high yielders, like NZD, even as its rates have been cut twice this year.

We see a mixed outlook for emerging market currencies driven by equity flows, but scope for high yielding currencies to retreat from their highs as yields rise.”