- President Donald Trump announced new tariffs on China worth roughly $50 billion annually.
- Bank of America Merrill Lynch says this escalation of global trade tensions could exacerbate one of the market’s biggest fears.
Now that President Donald Trump has officially announced roughly $50 billion of annual tariffs on Chinese exports, traders everywhere are scrambling to assess the market impact and position accordingly.
Among the biggest worries for investors is the US 10-year Treasury yield, which market experts say is on a worrisome ascent higher. Not only do higher yields put pressure on stocks by making them less attractive compared with fixed income, they also exacerbate fears that US government bonds are slipping into a bear market.
If those are the types of issues that keep you up at night, Bank of America Merrill Lynch has bad news for you.
The firm’s rates-strategy team says a “slow unwind of globalization” means yields will move higher in the medium to long term. The crux of BAML’s argument is that the Treasury market has received major support from foreign investors over the past 20 years, and any threat to that backstop could have a destabilizing effect.
As the chart below shows, foreign investors have accumulated about $6 trillion in Treasurys over the past two decades — roughly 40% of the market — through trade and intervention, according to BAML data.
BAML points out that trade has been a vehicle for many emerging-market countries to grow their economies. And they note demand for US Treasurys has received a boost from investor activity that has shifted toward building foreign-exchange reserves as emerging-market central banks work to debase their currencies.
“A meaningful slowdown in global trade may result in less FX reserve accumulation globally, reducing the need to buy US Treasurys,” a group of BAML strategists led by Carol Zhang wrote in a client note. “This may be a shot in the foot for the US just as the US expanded the fiscal deficit and is in need of sponsorship for the new debt.”
These developments are also affecting other asset classes, such as equities. For weeks, Wall Street has been expressing concern over how higher yields will affect stocks. Some have even gone as far as to single out the 3% level for the 10-year as a reckoning point for equities — and at 2.82% on Thursday, we’re close.
And as if traders didn’t have enough to worry about, the Federal Reserve reiterated on Wednesday its commitment to hiking interest rates at least twice more in 2018. That sort of monetary tightening is something that has historically boosted Treasury yields and spurred stock weakness.
With all of this in mind, how should investors be positioned? BAML says the best bet is to be short Treasurys and, by extension, long Treasury yields. Even though it’s already quite a popular trade, BAML stresses it’s not yet time to throw in the towel.
“We do not think it is time to give up shorting Treasuries,” Zhang said.
Leave a Reply
Leave a Reply
This site uses Akismet to reduce spam. Learn how your comment data is processed.
