Monthly economic e-news – May 2018
15 May 2018
LGS CIO, Craig Turnbull, looks at the threat of a trade war between the US and China, and what it may mean for the global economy and international markets.
By Craig Turnbull
Chief Investment Officer
Why are US Treasury bonds making the markets nervous?
Global markets have been volatile since the start of the year mainly due to geo-political events, potential trade wars, and one key economic indicator; the yield on 10-year US Treasury bonds.
Many analysts consider the yield on these bonds a good measure of investor confidence and inflationary expectations, and this yield has been steadily rising over recent months, briefly popping over the 3% level in late April.
Source: Yahoo Finance
Why is the yield on US Treasury bonds so important?
Treasury or Government bonds are what’s known as a debt instrument and this means that the yield, or the amount of return an investor realises on the bond, has an inverse relationship with the price of the bond. So put simply, as the price goes down, the yield goes up.
In most advanced economies, these bonds are government guaranteed and this translates into little or no risk for investors. However, this also means that the yield, or the rate of return, is usually lower than the return on other investments such as shares, property or even term deposits.
When confidence is low, or during periods of geopolitical tension, investors often turn to the safety and security of government bonds, and US Treasury bonds, in particular, are seen as a safe haven for international investors.
However, when share and property markets are rising, investors become more confident, switching out of government bonds and into these higher risk investments, driving down the price of bonds and inflating the yield.
So essentially, the yield on US Treasury bonds acts as an economic indicator. When yields start to become very low or very high, it may signal a possible turn in the economic growth cycle.
What has been driving up the yield on US Treasury bonds?
The main factor driving up bond yields is rising investor confidence on the back of improving global economic growth over recent years, in particular, the strong resurgence of the US economy.
In fact, the annual US GDP growth rate has risen every quarter since June 2016, reaching 2.9% in March, and it’s estimated that up to 80% of this growth is a result of much higher rates of household spending.
This spending has been made possible by the decline in US unemployment which fell to just 3.9% in April, and the steady growth of US wages and salaries, currently around 4.5% per annum.
And all this good news is pushing up prices with the US annual inflation rate hitting 2.4% in March.
On the business side, the latest US corporate reporting season has been very positive with the best profit gains in more than seven years. Over 70% of US companies beat analysts’ forecasts including technology giants Google and Facebook which both reported stronger than expected earnings.
And with all this confidence in the air, investors in the US and around the world have been looking to capitalise on the positive sentiment; selling down Treasury bonds and pushing the yields higher.
But is this as good as it gets?
When the yield on 10-year US Treasury bonds reached the 3% mark in April, many commentators asked if the end of the current US growth cycle may be in sight.
There are concerns that higher wages, rising inflation and prospect of the US Federal Reserve increasing official interest rates will eventually eat away at company profits and reduce returns for investors.
So now may be a good time to talk with your financial planner and review your investment strategy to make sure you have the right balance of risk and return in your super, and across your wider portfolio.
Markets at a glance
for the month ending 30 April 2018:
Australian shares1 up by 3.91%
Australian Government Bonds yield2 up to 2.765%
Australian dollar down to US$0.7570
Cash rate3 steady at 1.50%
International shares4 up by 0.91%
1 ASX 200 Accumulation Index
2 Yield on 10 year Australian Government Bonds
3 RBA cash rate
4 MSCI – World ex Australia (USD)