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  • Coronavirus supporting positive US dollar flows.
  • Foreign residents increased their holdings of long-term US securities in December.
  • AUD and JPY to continue facing pressures in US dollar strength. 

Considering the coronavirus, markets are paying particular attention to global yields. The Aussie trades as a proxy to the theme of the virus and it is interesting to note that the currency continues to strength despite rate cut expectations. Looking to yields overnight, we had the Australian 3-year government bond yields falling from 0.72% to 0.70%, 10-year yields from 1.04% to 1.01%. But the markets are “pricing in just a 5% chance of easing at the next RBA meeting on 3 March, and a terminal rate of 0.46% (RBA cash rate currently at 0.75%),” according to analysts at Westpac.

Analysts at ANZ argued, however, that the market has given up on the RBA cash rate ever returning to what might have been considered ‘normal’:

“This is evident in the small difference between the RBA cash rate and the 10y overnight interest rate swap – a difference we refer to as the ‘policy expectations curve’. A flat policy expectations curve has important implications for the fixed income market. In particular, the absence of a term premium forces investors to search out spreads to generate return. We think this generally supportive backdrop for spreads will remain in place until the policy expectations curve materially steepens.”

The analysts argued that potential triggers for such steepening include much higher global interest rates, a much lower AUD or a sizeable fiscal easing. “We don’t see any of these emerging as triggers for a steeper curve anytime soon.”

As for US yields, the 2-year treasury yields extended yesterday’s decline, from 1.40% to 1.39% while the 10-year yields slid from 1.55% to 1.54%. This was despite a drop in US stocks owing to the news that Apple warning that disruption in China from the coronavirus will mean revenues falling short of forecasts. The tech giant said production and sales were affected, and that “worldwide iPhone supply would be temporarily constrained”. 

As the stock market slips away, yields tend to rise, although what we are seeing here is a risk-off theme as investors seek out safe havens in US bonds. If this is to continue, despite the narrowing of the spread between the US, Japan and Australian yields, the US dollar can continue to rise on the 99 handle regardless which should ultimately pressure the yen ad AUD, until, of course, markets begin to facto in Federal Reserve rate cuts. “Markets are pricing a 10% chance of easing at the next Fed decision on 18 March, and a terminal rate of 1.10% (vs Fed’s mid-rate at 1.63% currently, effective FFR at 1.58%),” analysts at Westpac explained. 

Foreign residents increased their holdings of long-term US securities in December

Meanwhile, the details of the US Treasury International Capital Report gave a glimpse of the investment activity of foreign investors, a significant buyer base of the US government bond market was released overnight. The sum total in December of all net foreign acquisitions of long-term securities, short-term US securities, and banking flows was a net TIC inflow of $78.2 billion. Of this, net foreign private inflows were $134.2 billion, and net foreign official outflows were $56.0 billion. Foreign residents increased their holdings of long-term US securities in December; net purchases were $60.7 billion. The next release, which will report on data for January 2020, is scheduled for March 16, 2020.