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US yield curve steepens on possibility of ‘blue wave’ election

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The US yield curve has steepened sharply as investors weigh the prospects of a Democratic victory in the upcoming US election and the potential of more aggressive fiscal policy. 

On Tuesday, the yield on five-year Treasury notes was at one point 1.27 percentage points below that of 30-year government bonds — the widest gap since 2016, save for a brief intraday move in June — after investors ditched ultra-long securities at a faster pace than their shorter-term counterparts. 

The gap later shrunk to 123bp after President Donald Trump called off talks with congressional Democrats regarding a new relief package, effectively punting the issue until after the November 3 election.

At the high of the day, the yield on 30-year Treasuries had risen 0.14 percentage points since the start of the month to 1.6 per cent, while the benchmark 10-year yield was up 0.1 percentage points to 0.78 per cent. They fell to 1.5 per cent and 0.74 per cent, respectively, after the stimulus talks news.

Shorter-dated Treasuries have budged less this month, with two-year yields steady at 0.14 per cent and five-year notes slightly lower at 0.31 per cent. 

Line chart of Difference between five-year and 30-year Treasury yields, basis points showing Yield curve steepens as investors consider Democratic sweep

Investors said the back-up in longer-dated Treasury yields in recent days was driven in part by the growing chance that the November 3 election could result in a “blue wave” whereby the Democrats clinch the presidency and both chambers of Congress.

This is likely to pave the way for more ambitious relief packages to support the fledgling US economy and more Treasury securities flooding the market to fund it, they said.

Last week, modelling of poll data by FiveThirtyEight showed that Democrats had a 61 per cent chance of winning the Senate. That has since risen to 66 per cent. 

“A blue wave means more supply and therefore higher rates,” said Priya Misra, global head of rates strategy at TD Securities. “People realise that the Democrats are more in favour of bigger fiscal stimulus.”

Kathy Jones, chief fixed-income strategist at Charles Schwab, added: “It will be much easier to get fiscal stimulus through if there is a majority in both the Senate and the House and the presidency for Democrats.”

Federal Reserve policy has also played a critical role in the steepening of the yield curve, strategists said. The US central bank is currently buying $80bn of Treasury securities per month, across a range of maturities.

Investors have called on the Fed to tilt its purchases to longer-dated notes, given that the Treasury has ramped up issuance of this kind of debt. Without a firm commitment to do so, investors warn long-term bond yields will continue to feel upward pressure.

“What happens to the 10-year is dependent on what the Fed does,” said Ms Misra. “They are the marginal buyer.”

Jay Powell, the Federal chair, has told US policymakers that providing too little support for the American economy would be far more dangerous than offering excessive help. In an appearance on Tuesday, he stepped up his calls for a new stimulus package, saying the economic recovery from the damage inflicted by the coronavirus was “far from complete”.

Ms Jones said the recent steepening of the yield curve also reflected improving expectations for the US economy — especially if more robust government support does eventually come. While labour market improvements have begun to stall, fears about a double-dip recession or a much more pronounced deflationary spiral have been kept at bay.

“It reflects more optimism about the future,” she said. 



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Markets

European markets recover after tech stock fall

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European equities rebounded from falls in the previous session, when fears of a US interest rate rise sent shares tumbling in a broad decline led by technology stocks.

The Stoxx 600 index gained 1.3 per cent in early dealings, almost erasing losses incurred on Tuesday. The UK’s FTSE 100 gained 1 per cent.

Treasury secretary Janet Yellen said at an event on Tuesday that rock-bottom US interest rates might have to rise to stop the rapidly recovering economy overheating, causing markets to fall.

Yellen then clarified her remarks later in the day, saying she did not think there was “going to be an inflationary problem” and that she appreciated the independence of the US central bank.

Investors had also banked gains from technology shares on Tuesday, after a strong run of quarterly results from the sector underscored how it had benefited from coronavirus lockdowns. Apple fell by 3.5 per cent, the most since January, losing another 0.2 per cent in after-hours trading.

Didier Rabattu, head of equities at Lombard Odier, said that while investors were cooling on the tech sector, a rebound in global growth at the same time as the cost of capital remained ultra-low would continue to support stock markets in general.

“I’m seeing a healthy correction [in tech] and people taking their profits,” he said. “Investors want to be much more exposed to reflation and the reopening trades, so they are getting out of lockdown stocks and into companies that benefit from normal life resuming.”

Basic materials and energy businesses were the best performers on the Stoxx on Tuesday morning, while investors continued to sell out of pandemic winners such as online food providers Delivery Hero and HelloFresh.

Futures markets signalled technology shares were unlikely to recover when New York trading begins on Wednesday. Contracts that bet on the direction of the top 100 stocks on the technology and growth-focused Nasdaq Composite added 0.2 per cent.

Those on the broader S&P 500 index, which also has a large concentration of tech shares, gained 0.3 per cent.

Franziska Palmas, of Capital Economics, argued that European stock markets would probably do better than the US counterparts this year as eurozone governments expand their vaccination drives.

“While a lot of good news on the economy appears to be already discounted in the US, we suspect this may not be the case in the eurozone,” she said.

Brent crude, the international oil benchmark, was on course for its third day of gains, adding 0.7 per cent to $69.34 a barrel.

Despite surging coronavirus infections in India, the world’s third-largest oil importer, “oil prices have moved higher on growing vaccination numbers in developed markets”, said Bank of America commodity strategist Francisco Blanch.

Government debt markets were subdued on Wednesday morning as investors weighed up Yellen’s comments with a pledge last week by Federal Reserve chair Jay Powell that the central bank was a long way from withdrawing its support for financial markets.

The yield on the 10-year US Treasury bond, which moves inversely to its price, added 0.01 of a percentage point to 1.605 per cent.

The dollar, as measured against a basket of trading partners’ currencies, gained 0.2 per cent to its strongest in almost a month.

The euro lost 0.2 per cent against the dollar to purchase $1.199.



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Yellen says rates may have to rise to prevent ‘overheating’

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US Treasury secretary Janet Yellen warned on Tuesday that interest rates may need to rise to keep the US economy from overheating, comments that exacerbated a sell-off in technology stocks.

The former Federal Reserve chair made the remarks in the context of the Biden administration’s plans for $4tn of infrastructure and welfare spending, on top of several rounds of economic stimulus because of the pandemic.

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy,” she said at an event hosted by The Atlantic magazine.

“So it could cause some very modest increases in interest rates to get that reallocation. But these are investments our economy needs to be competitive and to be productive.”

Investors and economists have been hotly debating whether the trillions of dollars of extra federal spending, combined with the rapid vaccination rollout, will cause a jolt of inflation. The debate comes as stimulus cheques sent to consumers contribute to a market rally that has lifted equities to record levels.

Jay Powell, the Fed chair, has said that he believes inflation will only be “transitory”; the central bank has promised to stick firmly to an ultra-loose monetary policy until substantially more progress has been made in the economic recovery.

The possibility of interest rates rising has been a risk flagged by many investors since Joe Biden’s US presidential victory, even as markets have continued to rally.

Yellen’s comments added extra pressure to shares of high-growth companies, whose future earnings look relatively less valuable when rates are higher and which had already fallen sharply early in Tuesday’s trading session. The tech-heavy Nasdaq Composite was down 2.8 per cent at noon in New York, while the benchmark S&P 500 was 1.4 per cent lower.

Market interest rates, however, were little changed after the remarks, with the yield on the 10-year Treasury at 1.59 per cent. Yellen recently insisted that the US stimulus bill and plans for more massive government investment in the economy were unlikely to trigger an unhealthy jump in inflation. The US treasury secretary also expressed confidence that if inflation were to rise more persistently than expected, the Federal Reserve had the “tools” to deal with it.

Treasury secretaries generally do not opine on specific monetary policy actions, which are the purview of the Fed. The Fed chair generally refrains from commenting on US policy towards the dollar, which is considered the prerogative of the Treasury secretary.

Yellen’s comments at the Atlantic event were taped on Monday — and she used the opportunity to make the case that Biden’s spending plans would address structural deficiencies that have afflicted the US economy for a long time.

Biden plans to pump more government investment into infrastructure, child care spending, manufacturing subsidies and green energy, to tackle a swath of issues ranging from climate change to income and racial disparities.

“We’ve gone for way too long letting long-term problems fester in our economy,” she said.



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Senior Fed official in line to lead top US banking regulator

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Michael Hsu, a senior Federal Reserve official responsible for supervising the largest US banks, is poised to become the next acting comptroller of the currency, ending weeks of uncertainty over the US financial regulator’s leadership.

Janet Yellen, the US Treasury secretary, was set to tap Hsu for a senior post at the Office of the Comptroller of the Currency that would pave the way for him to become acting chief, according to people familiar with the matter. The timing of the announcement could not be determined.

Hsu is currently associate director of the Fed’s bank supervision and regulation division.

He has emerged as a more technocratic choice to lead the OCC compared with other possible choices with higher political profiles, such as Michael Barr, a professor at the University of Michigan and former Treasury official under Barack Obama who was a leading contender for the job. Some progressive Democrats have also been pushing for Mehrsa Baradaran, a professor at the University of California at Irvine, to be selected for the job.

President Joe Biden has not yet chosen anyone to permanently fill the post, which requires Senate confirmation. The White House declined to comment. Yellen’s decision to choose Hsu to lead the agency on an interim basis was first reported by The Wall Street Journal.

Through his role at the Fed, Hsu has great familiarity with the health of the largest banks. The mission of the OCC, which is housed within the Treasury department, is to ensure that national banks “operate in a safe and sound manner, provide fair access to financial services, treat customers fairly, and comply with applicable laws and regulations”, according to its website.

The Biden administration is expected to take a tougher approach to financial regulation than Donald Trump’s officials, amid concerns that hefty doses of fiscal and monetary stimulus flowing through the US economy as it rebounds from the pandemic is fuelling greater risk-taking on Wall Street.

Blake Paulson, the current acting chief of the OCC, was installed by Steven Mnuchin, the former US Treasury secretary, on January 14, less than a week before he left office.



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