recession economy

10 Year Treasury reaches 5%, an alarm for risky assets

The 10-year Treasury bond yield is widely recognized as the benchmark for the global cost of capital and a measure of risk-free returns. Consequently, the disparity between the earnings yield of the S&P 500 index and the yield on the 10-year Treasury bond represents the risk premium associated with stocks.

Stock risk represents the degree to which stocks are perceived as an appealing investment in comparison to other asset classes. In the present circumstances, stock risk has plummeted to near-zero levels, signifying that stockholders are not being rewarded for assuming additional risk. This situation has created significant pressure within the stock market.

The current level of risk is at its lowest point in the past two decades. This decline in risk can be attributed to various factors, including the rise in the dollar index. However, this situation carries substantial implications, particularly for economically disadvantaged countries. It makes it increasingly challenging and costly for these nations to service and repay their debts.

The convergence of these factors, with stock risk hitting historic lows and the strengthening of the dollar, underscores the complex dynamics impacting both global financial markets and the economic well-being of nations with high debt burdens.

This phenomenon demands careful monitoring and analysis as it can have ripple effects throughout the financial world and international debt markets.

The yield curve is the difference between the yields of ten-year and two-year bonds; In normal economic conditions, naturally, the yield of ten-year bonds should be higher than the yield of two-year bonds.

Inversion means that the yield of two-year bonds is higher than the yield of ten-year bonds; Since the 1970s, whenever there has been an inversion of the yield curve, we have seen a recession in the coming months.

Due to the existence of inflation and the increase in yield of bonds due to the increase in interest rates, it is not possible to get a definite recession signal from the current inversion and more data needs to be examined.

A recession is a period of economic decline characterized by a decrease in economic activity, rising unemployment rates, and reduced consumer spending. During a recession, the concept of the “Dollar smile” refers to a graphical representation of the U.S. dollar’s exchange rate. It illustrates that the dollar tends to strengthen during both economic downturns and periods of strong economic growth, forming a smile-like shape on a chart. This phenomenon suggests that investors often seek the safety of the U.S. dollar as a global reserve currency during times of uncertainty, making it a preferred asset in their portfolios.

The risk of recession is closer than ever

A sharp inversion of the yield curve and the possibility of recession

The yield curve is the difference between the yields of ten-year and two-year bonds; In normal economic conditions, naturally, the yield of ten-year bonds should be higher than the yield of two-year bonds.

Inversion means that the yield of two-year bonds is higher than the yield of ten-year bonds; Since the 1970s, whenever there has been an inversion of the yield curve, we have seen a recession in the coming months.

Due to the existence of inflation and the increase in yield of bonds due to the increase in interest rates, it is not possible to get a definite recession signal from the current inversion and more data needs to be examined.

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USD strengthened by Treasury bond yields

USD strengthened due to the increase in Treasury bond yields driven by strong economic data from the United States

The US dollar (DXY) is rising against major currencies as strong economic data and higher Treasury yields bolster its strength.

The U.S. dollar strengthened against major currencies on Thursday as strong U.S. economic data pushed Treasury yields higher. The positive news weighed on the euro and Japanese yen as investors looked to the dollar as a more attractive asset.

Pressures of monetary policy divergence

The currency hit a seven-month high against the Japanese yen as Federal Reserve Chairman Jerome Powell signaled the possibility of two rate hikes this year and did not rule out a hike in July. In contrast, Bank of Japan Governor Kazuo Ueda stressed the need for sustained inflation of 2 percent and wage growth before considering an exit from ultra-easy stimulus.

Japanese government officials have expressed concern over the rapid appreciation of the dollar against the yen, raising verbal warnings and the possibility of intervention in the currency market. Last year, when the dollar exceeded 145 yen, the Ministry of Finance and the BOJ stepped in. Currently, the dollar increased by 0.25% to 144.855.

Mixed inflation data weighs on the euro

Meanwhile, the euro faced mixed inflation data from Germany and Spain. Although consumer prices in Germany’s most populous state, North Rhine-Westphalia, rose 6.2 percent year-on-year in June, up from 5.7 percent in May, a similar pattern was seen in other states. Spain eased 12-month inflation to 1.9 percent, the lowest since March 2021, but still above economists’ expectations of 1.7 percent.

Looking ahead, investors are closely monitoring future inflation figures in the Eurozone, which could impact the Euro’s performance.

Short term forecast

As a result, the US dollar’s gains against major currencies were driven by strong US economic data and higher Treasury yields. While the euro faced mixed inflation data, the Japanese yen was affected by diverging policy plans between the Federal Reserve and the Bank of Japan. The potential for foreign exchange intervention adds another layer of uncertainty to the dollar-yen parity. Traders will monitor future economic indicators and central bank actions while moving in the currency markets.


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