Central banks – will they won’t they? – Episode 120 of Damien’s Midweek Podcast

5 min Read Published: 08 Sep 2021

The 120th episode of my weekly YouTube show where I discuss what is happening in investment markets and what to look out for. This week I talk about how central banks are likely to impact markets in the weeks ahead.

Each show lasts between 5-10 minutes and is aimed at DIY investors (including novices) seeking contemporary analysis to help them understand how investment markets work.

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Abridged transcript - Midweek Markets episode 120

I closed out last week’s show by commenting on how the market remains obsessed with the 10 year US treasury yield. At that point, the 10 year US treasury yield remained in its downtrend and sat at 1.29%.

I highlighted how we’d seen a run of higher lows in the preceding weeks which meant that the downtrend was being tested. Much depended on whether yields finally managed to break higher and I surmised that if the 10 year US treasury yield broke above 1.3% it would interesting and that once again we would probably see a lot of equity market rotation, just as we’ve experienced a number of times already this year.

Fast-forward to a week later, admittedly a shortened week as equity markets were closed in the US on Monday, and bond yields have broken higher. Right on cue, after managing to break the 1.3% level, and therefore the downtrend channel I’ve been discussing, the 10 year US treasury yield burst higher towards the 1.4% level. It currently sits at just below 1.36%

It means that the short term trend in US treasury yields has shifted upwards, as long as it can stay above the 1.29-1.3% level.

As result, we saw a big equity market rotation on Tuesday in the US. Stagflation favouring sectors were down hard on the day, Utilities fell 1.32% and Real Estate shares fell 1.11%. By contrast financial and only energy stocks fell 0.6% - these are sectors that were reflation trade beneficiaries. But interestingly healthcare stocks only fell 0.6% too. Perhaps the latter is a nod to concerns over rising COVID numbers.

However, despite disappointing jobs data from the US on Friday, in the last few days the market narrative has changed from one focused on stagflation and continued monetary support from global central banks, to a narrative that is concerned that central banks will begin removing support. Hence the rally in US treasury yields.

But the rise in government bond yields wasn’t just a US phenomenon. Just like its US counterpart, the 10 year UK gilt yield hit a two month high this week and currently sits at 0.72%.

Traders have begun betting that the US Federal Reserve will reduce its $120bn monthly bond purchases. Likewise, traders are increasing bets that the European Central Bank (the ECB) may announce a reduction in its own bond-buying (QE) programme at this Thursday’s meeting.

The shift in narrative hasn’t just caused bond yields to rise on both sides of the Atlantic it also caused some equity market weakeness. The German DAX, for example, is down 1.3% today as I make this show while the UK’s major stock market indices are down around 0.6%. US equities are currently down a similar amount.

There is no sign that the new moves in the bond and equity markets will continue or indeed accelerate, but it highlights once again that markets are trying to front-run central banks. The will-they-won’t-they narrative, when it comes to removing monetary stimulus, is likely to continue in the coming days and weeks right up until the Bank of England and the Fed’s policy meetings occur on the 23rd and 22nd of September respectively.

So hang on to your hats. If the Fed in particular gets things wrong and is deemed to have tightened monetary policy prematurely then you only have to go back to the autumn of 2018 to see the potential impact. To give you a hint… US stocks fell more than 20%, dragging global equity markets with them.

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