My Diary 568 --- Treasury Tumbled, jeopardizing stock market

M: Fundamentally, lower mortgage rates are not the reasons for recent asset reflation.

Here are my thoughts: Imagine if there is a global balance sheet, then who is the biggest beneficiary of the massive monetary/quantitative easing instigated by DM central banks to combat the “credit crunch”?

It will be the Asian and EM assets, given the currency or monetary policy links, and thus the related reflation story. Same important point is that given health sovereign balance sheet, EM countries has no structural domestic constraints to boost the internal growth, while the collapse in funding costs will serve to boost local asset price reflation.

Thus, since October 2008, MSCI AxJ and the MSCI Emerging Markets have risen by 56% and 57% respectively. In contrast, MSCI World and SP500 have risen by only 16% and 8% over the same period.

W:
Last night U.S. stock market retreated by 1.2%, but more eye-catching news is that $14 billion U.S. Treasury auction pushed 30-year treasury yield up 16bp to 4.25%.  10 year treasury yield also rose 11bp to 3.29%, all new high since Lehman’s bankruptcy.  Now the difference between 30 year mortgage rate (4.79%, May 1) and 30 year treasury yield (4.25%) is only 54bp, probably the lowest spread in history.  In my view, the rally in treasury has already started to jeopardize the property market’s ‘stabilization’ and the stock market rally. 

I am always of the view that this round of ‘economic recovery’ and stock market rally was driven by extremely low interest rate: (1) China’s mortgage rate 4.16%, markedly lower than 2008’s 6.66%; (2) U.S. 30-year fixed mortgage rate 4.8%, much lower than 2008’s 6.0-6.5%.  Low mortgage increased purchasing power of Chinese property buyers and reduced U.S. borrowers’ debt burden so as to result in a ‘recovery’.  But this recovery is very fragile because it relied on continued low mortgage rate.  If mortgage is to rise slightly to ‘normal level’, the economy may slide again.   

With regard to the stock market, after the 2 months’ sharp rally and continued signs of economic recovery, people tend to think economy is healthy again.  But rising U.S. treasury yield may dampen people’s sentiment that without the ‘drug’, we still cannot live.   For the Fed, it started talking about QE ‘exit’.  But if fast rising treasury yield increase the urgency to purchase more treasuries, what is the excuse of more QE when everything is ‘recovering’?

I am of the view that sharp rising U.S. treasury yield may mark the end of fasting rising stock price; more volatility is expected going forward.