Risk on and Risk off, who will win out?

Last week saw stocks hit record highs, sovereign bonds rally to a 2-year high, oil surge and gold move to a 26-month high. What is strange about this is that assets that are considered risky (equities) and safe (sovereign bonds and gold) are gaining value at the same time, this doesn’t usually happen, and it is starting to rattle some investors. 

What we can learn from US Treasury yields 

The question is, who is right? So much money moved into the bond market last week that the 10-year US Treasury yield fell below 2%, which is a major psychological level. Although the yield picked up again by 5 basis points on Friday and closed the week a tad above 2% at 2.059%, this is still close to the lowest level since 2016. The last time the 10-year US Treasury yield was this low was November 2016, back then the S&P 500 was decidedly range-bound. 

However, in the following 12 months the S&P 500 rallied some 600 points, which corresponded with the US Treasury yield rallying some 30 points over the same time frame. This tells us two things: low interest rates are positive for stocks, however, for a sustained rally in equities to take place, the economy needs to pick up, which will cause the US Treasury yield to rise (and a moderate rise is preferable for stocks). History does not always repeat itself, and this time around the S&P 500 is close to record highs, however, history does tell us that equities and bonds don’t move in unison for long, so one of these asset classes may have to head lower sooner or later.

Why this week could be a game-changer 

US bond yields (which move inversely to price), have fallen by more than 80 basis points so far this year. This is a huge move for the usually sclerotic bond market, the 10-year yield ended 2018 only 30 basis points higher compared to the start of the year. The next direction for Treasury yields could be dependent on the outcome of US economic data released this week and the all-important G20 meeting on Friday and Saturday. 

It’s all about the PCE, man… 

The economic data to watch out for this week includes: housing data and Fed Chair Powell’s speech on Tuesday, US durable goods trade on Wednesday, the final reading of Q1 GDP on Thursday and the all-important core PCE price index for May, which is released on Friday, and is the preferred inflation measure used by the Fed. This is expected to remain steady at 1.5%, which is an historically low reading and below the Fed’s target for inflation. The main reason for the dovish tilt at last week’s Fed meeting was considered to be the persistent low PCE readings this year. Due to the importance of this data point, even a small increase or decrease of just 0.1% could trigger a market reaction, with a lower reading triggering a further move lower in bond yields (higher in bond prices) and a boost to equities, and a higher reading causing a sell-off in bond prices, and rising bond yields, and a decline in equities. 

Will Trump and Xi make a trade deal at the G20? 

Perhaps the biggest event this week is the G20 summit, which takes place on 28thand 29thJune. The main event is the meeting that is expected between President Trump and President Xi of China. Expectations are high that both men will agree the terms for a US/China trade deal, which will bring an end to the trade tariffs and war of words between the two countries. From the markets’ perspective, the outcome of this meeting is binary. We get a trade deal and stocks rally/ bonds sell off, as the cloud hanging over the global economic outlook starts to shift; or, we don’t get a deal and stocks sell off sharply and there is a flight to safe havens like bonds, triggering and even larger decline in bond yields. At this stage, it is too difficult to tell which way this G20 meeting will go, thus, if you do plan on trading the G20 you will need to react quickly to any news that is released, and make sure that you have a good risk management plan in place. 

Turkish election result could see currency TRY harder 

Elsewhere, the Turkish lira could rally at the start of this week after Turkey’s opposition won a key mayoral election in Istanbul. This is a big loss to President Erdogan. Any sign that he is losing his grip on power in the country could trigger a boost to the TRY, as his leadership and economic policy has been disastrous for the value of the lira in recent years. At the start of this trading week the TRY has already made gains vs. the USD, and USD/TRY is down some 5%; this could be extended as we move through the week. 

US sanctions on Iran could be another boost for oil 

Also, worth watching this week are the expected US sanctions on Iran, as tensions between the two countries heat up. This could put added upward pressure on the oil price, as it may hurt the global supply. This could be an ongoing concern; thus, the oil price could be under upward pressure for some time. The Brent crude price has risen $5 per barrel already this month, to more than $65, any further supply concerns could see a move back to $70, the high from May. 

Trade idea: A pause in the gold rally, as investors weigh up risk factors 

Our idea of the week is gold. We mentioned last week that it was looking strong and a move back to $1,400 was on the cards. Strength in the yellow metal was fuelled by the dovish Fed and global economic concerns. However, there is a big risk on the horizon for gold bulls: the G20 meeting and a trade deal between the US and China at the end of this week. Gold traded above $1,400 last week, however it closed below this key level on Friday, suggesting some trepidation as we move towards the G20 meeting. Thus, bulls should pause here. A pullback towards $1,380 would need to attract significant buying interest before we get bullish on the gold price in the short term.