Idea of the Day Rising US Treasury yields are not a catastrophe for risk yet

The 10-year US Treasury yield is worth watching closely in the coming sessions. It is close to a key resistance level at 2.4%, see chart 1 below, this is the third time since March that it has attempted to break above this level, and above here opens the way to the highest level for a year for the 10-year yield at 2.62%.

If the 10-year yield can clear this level then it would be a major milestone for financial markets, and may have a big impact on the following asset classes:

• USD/JPY
• US stock indices
• The dollar index
• Emerging market assets

The USD/JPY has the highest correlation with the 10-year yield at 0.84, compared with 0.70 for the S&P 500 and 0.5 for the dollar index. USD/JPY’s relationship with the 10-year yield is the strongest historically, while the S&P 500’s relationship with the Treasury yield had been at approx. 0.5 until September of this year when it surged to 0.70. The dollar index’s relationship has been steady at approx. 0.5 for the duration of 2017.  

Surprisingly, our correlation analysis found that there was little correlation of note, both in the short and long term, between the US Treasury yield and the MSCI Emerging markets index. There has been a lot of concern voiced by market pundits that once Treasury yields started to rise then emerging market assets would be at risk. We believe that this will be the case, however, our analysis, albeit limited, suggests that yields may have to rise to a much higher level, say above 2.6%, before they start to hurt emerging market assets.

This does not mean that emerging market assets are immune, a lot of money has piled into EM assets in recent years and if US Treasury do make a significant break higher then we could see global yield-hunters start to pile money back into the US bond market and even US stocks. This may sound counter-intuitive, why would US stocks rise when yields rise? This is a valid question, but US stocks should do well in a higher yield environment as long as yields do not get too high. Eventually a rise in Treasury yields would leave both US stocks and some emerging market assets at risk of a rush for the exits. For example, Thai bonds could be at risk since 10-year Thai government bond yields are currently yielding virtually the same as 10-year US yields (see chart 2 below).

Overall, if the yield breaks above 2.4% and makes its way towards 2.6%, we think that this is will cause a rally in USDJPY, US stocks could push higher and emerging market assets should be relatively immune. However, if the Treasury yield continues its rally past 2.6% then we believe US stocks and emerging market assets, in particular, could be at risk.