Treasury yields and dollar rise as Fed confirms rate-hike expectations

Week of September 29

Last week, we saw government bond yields rise across the globe. The 10-year US Treasury benchmark, in particular, increased by 8 basis points on Wednesday, buoyed by warnings from Fed Chair Janet Yellen that policymakers should not move “too gradually” when raising rates, despite weaker-than-expected consumer price growth. In addition to the fact that markets had already assigned a relatively high probability to a potential rate hike in December, the comments seemed to confirm this notion and put even more pressure on bond prices.

The same-maturity British Gilt and German Bund rates were also lifted by 5 and 6 basis points, respectively. The two European benchmarks, however, ended the week only marginally higher, as results of the German election the previous Sunday weighed on bond yields. The strong entrance of the rightwing populist Alternative for Germany party left re-elected Chancellor Angela Merkel struggling to find coalition partners for a stable government, and investors sought the relative safety of government securities.

Meanwhile, American stock indices posted new highs, elevated by both the hawkish Fed assessment and a revived anticipation of tax cuts from the Trump administration. Oil futures were also boosted by 2% over potential supply problems after Turkey threatened to cut off Kurdish crude exports following the independence referendum in Iraq.

The US dollar was also lifted by prospects of higher interest rates and lower taxes, appreciating 1% against a basket of foreign currencies. Gains were even more pronounced versus the euro, which depreciated 1.2% relative to the greenback, further weighed down by concerns about the outcome of the German election.

At the same time, short-term risk in Axioma’s global multi-asset class model portfolio decreased by another 0.19% to 3.12%. The most notable reduction occurred in the US equity category, where the percentage risk contribution dropped from almost 40% the week before to 23% as of last Friday. Part of this was due to lower stock market volatility, though the majority came from the negative correlation between FX and equity factor returns. The latter was caused by the renewed inverse relationship between share prices and foreign currency exchange rates versus the USD, which offset a large part of non-USD stock market movements.

Oil also showed a more negative correlation with foreign currencies, in particular the euro. This, combined with its high standalone standard deviation, made the commodity appear like an excellent diversifier against non-USD assets, which, in turn, resulted in a negative contribution of 0.11% (or -3.6% of total portfolio volatility).

Christoph Schon, CFA, CIPM

Christoph Schon is the Executive Director, Applied Research for EMEA at Axioma, where he generates insights into recent risk trends with a particular focus on fixed income and multi-asset class analysis. Christoph has been in the portfolio risk and performance analysis space for more than 10 years, having previously worked for Lehman Brothers/Barclays POINT and UBS Delta.