SWEDISH KRONA IS EUROPE'S WEAKEST CURRENCY -- FALLING COMMODITIES ALSO HURT AUSSIE AND CANADIAN DOLLARS -- TREASURY YIELDS ARE HIGHLY CORRELATED TO LOWER GERMAN YIELDS -- TREASURY YIELD JUMPS TO TWO-MONTH HIGH -- BOND ETFS HAVE WORST WEEK IN A YEAR
MORE CURRENCY WEAKNESS... My mid-week message on the broadbased nature of the U.S. dollar rally showed a number of falling currencies, including the Euro, the Swiss franc, the British Pound, the Japanese yen, and the Canadian Dollar. Chart 1 adds two more. The blue line shows the Swedish Krona tumbling nearly 10% since the start of year (making it the weakest currency in Europe). The green line shows the Australian Dollar falling to a six-month low. The drop in the Aussie is due to the unwinding of "carry trades" when investors borrow low yielding currencies (like the U.S. dollar) and invest in higher-yielding currencies (like the Aussie). With U.S. rates rising along with the dollar, forex traders are unwinding those trades by selling higher-yielding currencies. The Aussie and Canadian Dollars are also being hurt by the drop in commodities.
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Chart 1
FALLING COMMODITIES HURT AUSSIE AND CANADIAN DOLLARS... Earlier this year, I wrote a message about how rising commodities were helping these two resource-based currencies. Today's message shows just the opposite. Falling commodity prices since the end of June have contributed to drops in both currencies. Both currencies peaked with commodity prices in early July (see circle). The Canadian Dollar weakened more,, while the Australian Dollar held up better until this week (when the unwinding of the carry trade kicked in). Both currencies get hit with a double whammy when the U.S. currency rises. First, they usually lose ground against the U.S. dollar itself. Secondly, they also lose when the rising dollar pushes commodity prices lower.
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Chart 2
BOND YIELDS ARE POSITIVELY CORRELATED... Previous messages have explained my view that the 2014 drop in Treasury bond yields may have more to do falling yields abroad, and less to do with the U.S. economy. The best example of that is the comparison between U.S. and German yields. The green line in Chart 3 shows the 10-Year Treasury yield ending the week at 2.62% (more on that shortly). The German 10-Year yield climbed to 1.08% this week. The spread between the two yields is the widest in fifteen years. And they're highly correlated. The 120-day Correlation Coefficient (below chart) has been positive (above zero line) all year and ended the week at a very high positive value of .89. The fact that Treasury yields (as well as short-term yields) in the U.S. are so much higher than in the eurozone is a reflection of more optimism on the U.S. economy. It also reflects divergent policies where the Fed is within a month of ending its bond buying program, while Europe is just starting one of its own. That divergence in the two yields also explains why forex money has been selling the Euro (and most other currencies) and moving into the U.S dollar. It remains to be been if this week's rise in Treasury yields can be sustained without more strength in foreign yields. [Japan's 10-Year Yield (the lowest in the world) jumped to a two-month high of .58% on Friday].
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Chart 3
10-YEAR YIELD JUMPS TO TWO-MONTH HIGH ... Chart 4 shows the 10-Year Treasury Yield jumping sharply this week to the highest level in two months. That's the biggest jump in bond yields (and drop in bond prices) since the start of the year. The fact that the two-year yield rose to a new three-year this week (with a corresponding jump in the dollar) has raised expectations for a more aggressive Fed policy to be announced this week. Not a rate hike, but possibly a more hawkish tone at Wednesday's Fed meeting. Since long and short-term rates usually trend in the same direction, any hint of Fed tightening would raise all maturities. Investors are already selling their bond holdings.
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Chart 4
BOND ETFS BREAKDOWN... Greg Schnell's Friday blog showed the 20+Year Treasury Bond iShares (TLT) falling below its 2014 support line. Chart 5 shows the 7-10 Year T-Bond iShares (IEF) doing the same. That breakdown suggests that the 2014 bond rally may have run its course. Treasuries aren't the only bond prices falling. The weekly bars in Chart 6 show the iBoxx Investment Grade Corporate Bond iShares (LQD) having the worst week since the fund's rally started a year ago (and ending well below its 10-week average). The last time that bond fund turned lower was during the "taper tantrum" of spring 2013 when bond yields jumped sharply.
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Chart 5
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Chart 6
HIGH YIELD BONDS WEAKEN... Even high yield bonds are coming under pressure. The red daily bars in Chart 7 show the iBoxx High Yield Corporate Bond iShares (HYG) falling to a one month low after failing a test of its summer high. The appeal of high yield bonds is largely predicated on lower competing Treasury yields. That being the case, an upturn in the Treasury yield (green line) poses a threat to high-yield bonds (and high yielding assets in general). The presence of a potential "double top" on the HYG chart is another sign that the high yield bond rally may be ending.
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Chart 7
GOLD AND OIL STOCKS SHOW RELATIVE WEAKNESS... Two of the worst performing stock groups were gold and oil shares. Chart 8 plots the falling relative strength ratios of the Energy SPDR (XLE) and the Market Vectors Gold Miners ETF (GDX). That's not surprising considering that commodity prices are falling (as the result of a rising dollar). Rising interest rates are also bad for gold, which fell to a new eight-month low this week. Arthur Hill pointed out on Friday that rate-sensitive groups fell hard, which usually happens when yields are rising. Utilities lost more than -3% during the week and REITs an even bigger -5% loss. Apparently, the financial markets are taking the threat of rising bond yields more seriously.
