By Dr Mohd Afzanizam Abdul Rashid, Chief Economist of Bank Islam Malaysia Berhad,
One could easily perplexed to note that the 10-year US Treasury yields have been skidded down to below 1.40% of late. This happened at a time when talks of higher inflation appears to be gaining some steam with Brent crude oil prices have been sustaining above USD70 per barrel since May this year.
To top it off, the US economy has been flashing promising signs of recovery. The Nonfarm Payroll (NFP) came in at 850,000 jobs during June from 583,000 jobs in the preceding month. With more jobs being created, the unemployment rate has remained low at 5.9 percent in June from a high of 14.8 percent in April last year.
The Federal Open Market Committee (FOMC) meeting during June also clearly stated in their forecast that the Federal Fund Rate would be raised sometime in 2023. In the same vein, the Bank of England (BOE), while keeping the policy rate steady at 0.1 percent, the accompanying statement after the Monetary Policy Committee (MPC) meeting on 22 June suggested that the UK GDP in 2021 is expected to record to pre pandemic level.
Despite that, the US Treasury yield curve has been flattening since March with the spread between the 10-year and 3-months yields presently stood at 132 basis points as of July 7 from 173 basis points in mid-March this year. Typically, when the bond yield curve is flattening, it may signals that the economic outlook is likely to be less favourable.
What could be the possible explanation for the conundrum? One apparent reason could be issues revolving around Covid-19 as the new variant is deemed to be more transmittable and deadly.
Be that as it may, those who are bullish would think that the vaccination program which has proceeded well in the US and in other parts of advanced economies, may not buy this argument. Instead, they might see any correction in the risky assets such as equities is an opportunity to accumulate.
So what is the key takeaway from this? For starters, we may have to acknowledge that the negative shocks we are currently facing is not the same as the US Subprime Crisis in 2007 and 2008. Similarly, the Asian Financial Crisis in 1997 and 1998 recession was vastly different from the impact of the spread of Covid-19 diseases. It’s entirely different problems but the economic prescription appears to be mirroring when the economy is facing financial sector led recession. Something really amiss and therefore, we should not get our hopes up.
Where do we go from here? Being cautious is the wisest thing to do and it may rhymes with a seemingly common mantra “diversify, diversify, diversify”. It is going to be bumpy ride as the global economic recovery is expected to be uneven. Not to mention the lingering risks surrounding the relationship between the US and China which could easily tilt the balanced of risks to the downside. Efforts to preserve the environment through climate change initiatives could also have significant repercussion to the developing world as their priorities are different from those of the advanced countries.
Going forward, there is a chance that we could see some semblance from the past experience. The Taper Tantrum in mid-2013 could be repeated again. This may come as the US Fed would likely to shed more lights about their intention to reduce their asset purchases program totaling USD120 billion per month.
It could happen as the economic recovery would be supplemented with the President Joe Biden aspiration to improve the state of US infrastructure which presently rated at C- by the American Society of Civil Engineers (ASCE) in 2021. The bipartisan spending bill totaling USD973 billion would include USD109 billion on roads and highways, USD15 billion on electric vehicle infrastructure and transit system and USD65 billion toward broadband, airports, drinking-water system and climate change.
The fiscal spending would normally has an immediate impact to the economy and could easily raise the GDP level should the economy continues to reopen. In that sense, the US central bank could gradually remove some of the excessive monetary supports.
Essentially, the financial market is going to be volatile as the world would have to grapple with higher interest rates in the US. In a nutshell, brace for impact.