Risk market's throttled by a global surge in bond yields

Markets

US stocks dramatically reversed earlier gains as jittery investors processed a slew of economic updates, sending the S&P 500 tumbling by 1.1% and the tech-laden Nasdaq Composite plunging nearly 1.9%. Despite unveiling ambitious artificial intelligence initiatives, Nvidia torpedoed from its recent peak, reflecting the market's uneasy mood.

The day's losses were sharply exacerbated by a significant uptick in the 10-year Treasury yield, which surged about 7 basis points to just shy of 4.7%. This spike is a stark reminder of the shifting investor sentiment regarding the Federal Reserve's interest rate trajectory, especially following the Institute for Supply Management's manufacturing PMI. The report not only confirmed continued sector growth but alarmed markets with a substantial jump in the prices paid index to a nearly two-year high, signalling enduring inflation concerns.

Further stirring the pot, the Job Openings and Labor Turnover Survey (JOLTS) revealed an unexpected increase in job openings for November.

The latest JOLTS data paints a vivid picture of a labour market still bustling with opportunity. Job openings abound, signalling robust demand for workers despite a slight deceleration in hiring rates. Notably, there's scant indication that employers are gearing up for layoffs, underscoring a stable employment landscape. However, the dip in the quit rate to pre-pandemic levels hints at a more cautious workforce, less inclined to jump ship in search of enhanced pay or opportunities. Meanwhile, the jobs-to-jobless ratio has climbed to a five-month peak of 1.13, reflecting an increasingly competitive job market. This scenario showcases a workforce navigating cautiously amid a dynamic economic environment.

These developments sharply set the scene for this week's critical December jobs report. Recent Fed signals suggest a cautious approach to rate cuts amid a resilient job market and sticky inflation. Still, investors are now unanimously betting against any rate changes this month. Moreover, according to the CME FedWatch Tool, odds are tipping below 50% for a rate cut before June, underscoring a tense watch on the Fed's next moves.

The upcoming December employment report is anticipated to reveal that 150,000 workers were added to nonfarm payrolls, a decrease from November's robust addition of 227,000 jobs. Nonetheless, this level of job growth aligns closely with the average annual job creation seen in the years preceding the pandemic, underscoring the resilience of U.S. economic performance under the moniker of US exceptionalism.

Asia open

Investors in Asia are approaching Wednesday's market with a subdued risk appetite, throttled by a global surge in bond yields. U.S. Treasury yields, a critical benchmark for Asia markets heavily reliant on dollar-denominated debt, are in sharp focus, especially the medium- to long-term maturities.

The 10-year U.S. yield has reached an eight-month peak, and the 30-year yield is teetering just 10 basis points below the 5.00% threshold. This rapid ascent—60 basis points in just a month—signals a growing unease among bond vigilantes about the U.S.'s fiscal profligacy.

This week, market narratives are dominated by the need to absorb an increased bond supply amidst a holiday-shortened week due to President Carter's observance. However, the broader story is one of deepening fiscal concerns and the inflationary repercussions of America’s aggressive economic stance, now more scrutinized under "Trump 2.0."

Amid these dynamics, the Federal Reserve's unexpected hawkish shift in a typically rate-cutting phase complicates the financial scene. It suggests further upheaval in bond markets as investors grapple with looming fiscal and inflationary pressures.

In Japan, the depreciating yen contributed to a robust 2% surge in the Nikkei, propelling it back above the 40,000-point mark on Tuesday. However, the uplift may be short-lived; futures indicate a potential drop of up to 1% at Wednesday’s opening as Tokyo’s markets grapple with the repercussions of rising U.S. yields.

In China, the economic landscape appears increasingly bleak. So far this year, Chinese stocks have plummeted by 5%, starkly underperforming compared to regional and global counterparts. The yuan has weakened to its lowest level against the dollar since September 2023, while Chinese bond yields are in a freefall, signalling deep investor concerns.

This sharp decline in yields and the yuan's weakness underscore a troubling conflict: the yuan is still too overvalued to attract foreign investments, particularly against a backdrop of pervasive economic pessimism and a scenario reminiscent of Japan’s long-term deflationary spiral—often referred to as "Japanification." This economic scenario poses significant challenges for China as it tries to navigate these turbulent financial waters without deterring further foreign investment.

The prospect of impending tariffs looms large for China and, potentially, Japan, adding a layer of complexity to their economic landscapes. As U.S. President-elect Donald Trump doubles down on his aggressive approach to trade policy, these major Asian economies could find themselves navigating domestic economic challenges and the broader repercussions of heightened trade barriers.

Forex markets

Amid fluctuating sentiment about the breadth of potential U.S. tariffs under incoming President Donald Trump, the New York trading session showcased a stark turn toward U.S. exceptionalism, driven by unexpectedly strong economic data. This shift underscored a deepening policy divergence between the Federal Reserve and other global central banks. The surprising strength in the ISM's gnarly price-paid component, indicating persistent inflationary pressures, played a key role in this pivot. This robust data pulled the EUR/USD below 1.035o, elevated the USD/JPY above 158, and saw the offshore yuan approach 4.35, as tariff uncertainty momentarily moved to the background, overtaken by these compelling economic indicators.

With U.S. yields climbing, the prognosis of the Japanese yen and the Chinese yuan isn't promising without persistent intervention and strategic currency maneuvers from central banks. In Asia, traders remain on edge for potential interventions by Japan, as the dollar recently surged to 158.40 yen. The 160 level is regarded as a critical threshold at which the Bank of Japan might step in more forcefully.

Meanwhile, the narrative surrounding China remains gloomy, providing scant motivation for investors to engage with its struggling assets. U.S. President-elect Donald Trump has reiterated his stance to impose significant tariffs on imports from major trading partners, further complicating the economic landscape.

On the same note, China's foreign exchange reserves witnessed a sharp decline, dropping by $64 billion in December—the most significant monthly fall since April 2022 and reminiscent of the severe dips during the 2015-16 yuan devaluation and capital flight episodes. This steep decline underscores the intense pressure on the People's Bank of China, which continues to wield a heavy hand in currency fixing to stabilize the yuan. However, this manipulation often renders local assets unappealingly expensive for foreign investors, exacerbating the challenge of attracting external capital amidst ongoing economic uncertainty.

Oil prices

Oil prices rebounded after an initial dip in yesterday's trading, fueled by traders interpreting Saudi Arabia's decision to raise oil prices for Asian buyers next month as a bullish signal. This move suggests that Aramco's physical traders anticipate tighter market conditions in China due to economic stimulus effects. Additionally, industry quants noted a decrease in oil supply from Iran and Russia last month, factors that are crucial in driving supply constraints in Asia. Given that oil from Russia and Iran typically flows into the inventories of China's teapot refineries and other storage facilities, this reduction is seen as a significant driver of the current tight supply dynamics in Asia. Tighter supply and increasing demand are classic ingredients for rising oil prices.