“US-China Strains Drive Demand for Secure Assets, Trigger Treasury Yields Retreat!”

US Treasury yields declined on Monday due to a renewed increase in geopolitical tensions, which led to an upswing in demand for bonds. The current fluctuating environment is rendering investments in bond safety plays appealing. Bond yields move inversely to prices, rising as prices fall and vice-versa. The yield on the two-year Treasury Note dropped by 1.2bps to 3.974%, while the yield on the 10-year Treasury Note retreated by 4.3bps to 3.383% and the yield on the 30-year Treasury Note declined by 4.6bps to 3.575%.

This recent strength in the US bond market can be attributed to the latest disagreement between Beijing and Washington D.C., following a US Navy destroyer sailing through waters near the Spratly Islands in the South China Sea. A significant nexus for global trade, these islands are claimed by Beijing. As Ian Lyngen, head of US rates strategy at BMO Capital Markets, explained of the bond market response: “The overnight price action was credited to an increase in geopolitical saber-rattling following reports that the US Navy sent a destroyer through waters near the Spratly Islands claimed by Beijing.”

Worrisome trade developments have elicited a surge in demand for Treasury bonds, providing support for the bond market. Week on week, US Treasury yields fell dramatically towards October’s end, and the yield on the 10-year Treasury note dropped to a weeks’ low in response. A highly volatile October resulted in bond markets recovering losses from the nine months prior, as Wall Street hit a peak by midmonth.

The start of October saw a significant rise in 10-year Treasury note after it hit the critical 3% increase mark but, by mid-October, equity prices dropped in response to the rapid rise in bond yields. Escalating US-China trade spats and geopolitical tensions led to a significant demand for low-risk investments amid financial uncertainty. Increased yields in US Treasury notes are perceived globally as safer low-risk investments. Acting as a yardstick for various loans and leases, such fluctuations in global bond markets tend to impact businesses and consumers alike.

Additionally, the Treasury sector is experiencing a shift in focus regarding economic data releases, as the data is acting as a guide during the Fed’s decision-making process. Any signs of acceleration are likely to result in aggressive hikes, pushing economic rates up as Treasury yields rise in response.

Hikes also lead to a rise in general investor concerns regarding the rate of the Fed’s plans as quarterly Federal Open Market Committee (FOMC) statements are of assistance in guiding general investor sentiment. Changes to their economic forecasts bring the potential of impact to financial markets as a side-effect.

The mood in US markets is largely bearish, leaving little change to the Federal Reserve Funds (FFF) rate. Market movement at the FFF rate reached 2.1875%, with a mere 2bps deviation since the last hike. The next expected hike is slated for March 20, 2019, which is anticipated to be the first date when the rate surpasses 2.39% (2.4375%), the upper bound of the range. The penultimate increase for 2019 might come on October 30, adding another 25 basis points to the total rate by year end. Current market developments, however, make it impossible to pin down an exact date.

Meanwhile, the spread between the 10-year note and two-year note widened, gaining 1.1bps on October 30 alone, moving from 28.6bps to 29.7bps. The relation between the 10-year note and the two-year note reflects concerns about increasing rates and a predicted economic slowdown. The U.S-Treasury yield curve, which illustrates the relation between maturity and yield, led investors to move from riskier assets to bonds.


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