This week, unlike the week of September 17, the dollar followed U.S. yields higher.
That’s notable for a number of reasons and while I don’t want to dive into it all here, I do want to point out that i) it would appear that for the time being, hot U.S. economic data and favorable rate differentials are once again in the driver’s seat for the greenback while concerns about America’s deteriorating fiscal position have apparently been relegated to the backburner again, ii) the combination of rising U.S. yields and a stronger dollar has the potential to tighten global financial conditions.
On that latter point, Nedbank’s Neels Heyneke and Mehul Daya (who have spent quite a bit of time this year warning about the prospects for an acute dollar liquidity shortage) are out with a new note warning that we’re about to cross the Rubicon.
“The JPM Global Bond yield, after being in a tight channel, has now begun to accelerate higher [and] there is scope for it to rise another 20- 30bps, close to 2.70%, which is the ‘Rubicon level’ for global financial markets, in our view”, the duo write, in a note dated October 4, before warning that “if the JPM Global Bond yield rises above 2.70%, the cost of global capital would rise further, unleashing another risk-off phase.”
They go on to note that the combination of a stronger USD and the rising global cost of capital is a recipe for a “liquidity crunch”.
“Major liquidity crunches often occur when yield curves around the world flatten or invert [and] currently, the global yield curve is inverted, an ominous sign for the global economy and financial markets, especially overvalued stocks markets like the US”, Heyneke and Daya caution.
The good news is that for the time being, Nedbank expects the “Rubicon” level for global bond yields to hold, but warns that eventually, the cost of capital will break higher, with decidedly dour ramifications for risk assets.