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What caused the market selloff last week?


Last week, a spike in US Treasury yields sent investors selling out of risk assets, causing both the stock market and cryptocurrency market to drop quite substantially.

With better news coming out of the COVID-19 situation across the globe, expectations of improving economic activities have caused global government bond prices to fall and their respective yields to edge up since February 10, as proof of the efficacy of the vaccine is being witnessed in both the USA and Europe. Things got heated last Wednesday after Federal Reserve (FED) Chairman Jerome Powell’s testimony was deemed more hawkish as expected. Then came the US Treasury auction on Thursday which saw no buyer, which caused fears and started a rout of selloff in US Treasury bonds. US Treasury Yields, which moves in opposite direction as bond prices, spiked up on Thursday, sending chills to investors who started to sell their stocks and cryptocurrencies which accumulated into a huge market selloff. Gold, silver and oil didn’t escape the carnage and also retreated.

Powell’s comments that the rising yields were the result of strength in the economy, caused traders to think that the days of ultra-loose monetary policies are over and that a rate hike may happen sooner than expected.

Rising bond yields and rising interest rates are bad for businesses and risk assets because in a rising interest rate environment, repaying a loan gets more expensive. Rising US Treasury Yields in particular, makes repaying back the debt owed by the US government more expensive, in turn making the already bad debt situation worse for the US government.

Rising yields is bad for the markets in 2 ways,

  • it makes businesses less able to take on loans, or adds pressure to companies in that their interest payments may increase. Hence, growth of companies may be hindered, which will affect their earnings. Companies may report worse earnings, there is less money to go around since businesses do not fare well. If the companies are listed, the lousy earnings will affect their share prices.
  • Rising yields makes borrowing for investment or trading a lot more expensive and reduces borrowing to play the markets. As we are all aware, the ultra-low interest rates in the past decade have made it very easy for anyone to borrow funds to trade the market, which has made the market the highly leveraged one it is today. Should interest rates spike, leveraged traders need to pay more to service their loans, and may be forced to sell off their positions should they not be able to pay the higher interests, leading to more losses, which in turn leads to even more losses as margin calls get liquidated. Hence, this situation makes for a very fast and steep drop in the markets. Every risk asset out there, like gold, silver, cryptocurrencies, have all been highly leveraged and may see lots of liquidations if interest rates continue to spike.

The market sold off quite significantly last week due to such fears.

Investors tend to sell bonds when they expect faster economic growth and rising inflation, which lowers the value of bonds’ fixed payments and can eventually lead the FED to raise short-term interest rates. Even though in the FOMC meeting just passed, the FED reiterated its stance on accommodative monetary policies, investors didn’t seem to believe this as they felt that the FED was always behind the curve. Powell’s more hawkish than expected statement during his testimony last week didn’t sit well with traders.

To make matters worse, after Powell’s statement, the US Labour Department Data on Thursday showed that the number of jobless claims fell sharply last week, signalling an improvement in the job market. With COVID-19 cases showing a sharp drop as well, positive expectations of better economic activity, coupled with expectations of an increase in inflation, sparked the rise in yields, with the benchmark 10-year Treasury note reaching as high as 1.61%, its highest level in a year.

The rise in yields is not good for risky assets as mentioned, causing both the stock market and the cryptocurrency market to plummet. Gold and Silver also fell, with the sole beneficiary the USD, which has been pressured heavily for the most part of 2020. Should yields continue to rise and the USD strengthen further, it bodes very badly for the stock market which has been buoyed up by a decade of ultra-loose monetary policies and an unprecedented amount of leverage. The unwinding of positions and subsequent margin calls on leverage positions will send the markets spiraling downwards. Hence, monitoring the change in bond yield is an important activity any trader need to determine the direction of the markets.

On Friday nonetheless, yields have fallen back somewhat and looked to have stabilized. The yield on the benchmark 10-year Treasury note settled at 1.459%, down from 1.513% at Thursday’s close. One should keep watch of yield movement in the near future and whether the FED comes in to buy bonds to support the market should rates continue to rise.  If the FED does not and rates continue to rise, a market crash may be imminent.

About Kim Chua, PrimeXBT Market Analyst:

Kim Chua

Kim Chua is an institutional trading specialist with a track record of success that extends across leading banks including Deutsche Bank, China Merchants Bank, and more. Chua later launched a hedge fund that consistently achieved triple-digit returns for seven years. Chua is also an educator at heart who developed her own proprietary trading curriculum to pass her knowledge down to a new generation of analysts. Kim Chua actively follows both traditional and cryptocurrency markets closely and is eager to find future investment and trading opportunities as the two vastly different asset classes begin to converge.

 





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