(Bloomberg) — From Treasury yields hitting 3% to shorting technology stocks, traders are busy updating playbooks on what a more hawkish-than-expected Federal Reserve would mean for markets.
Mizuho Bank Ltd. is urging investors to sell bloated U.S. bond portfolios, on the risk 10-year yields climb to as high as 3%. Robeco is eyeing Japanese industrial stocks, while DBS Bank Ltd. likes Chinese government debt as a haven from Fed rate hikes. Invesco Asset Management sees technology shares coming under more selling pressure.
“Repositioning will be a no-brainer now with yields likely to climb higher, quantitative tightening quickening and equity sectors suffering nosebleeds as the Fed comes out swinging,” said Vishnu Varathan, head of economics and strategy at Mizuho. “The key thing to weigh here is the acceleration in the Fed’s tapering and whether markets are right with their pricing of hikes.”
A Treasuries selloff extended on Thursday, also pushing yields from Australia to Japan higher after minutes from the Fed’s December meeting showed policymakers considering hiking earlier than expected and mulling a runoff of its balance sheet. Equities slid with benchmarks in Australia and Japan leading losses after their U.S. peers tumbled overnight led by high-priced technology shares.
Heaviest Tech Selling in a Decade Fueled Stock-Market Rate Rout
Market participants are zeroing in on a key component of the minutes: that policymakers discussed shrinking their balance sheet soon after the first hike. It’s a more aggressive approach than first thought, spurring re-thinks on how best to position for rising U.S. borrowing costs.
Swaps traders now see a 76% chance the Fed will raise the policy rate by 25 basis points in March, compared with just 26% at the start of December. The 10-year Treasury yield rose two basis points to 1.73% Thursday, its highest since April. Real yields — those adjusted for inflation — have also jumped 20 basis points in just four days at a pace not seen since the height of pandemic fears in March 2020.
Benchmark U.S. yields should climb toward 2% as markets move into the second half of the year, said Andrew Ticehurst, a rates strategist at Nomura Holdings Inc. in Sydney. Australian bonds have the potential to outperform as the omicron wave increases the risks to growth, he added.
Sell Asia
Currency traders are already looking to pressure points in Asia, with the Thai baht plunging 1%, while commodity currencies like the Australian dollar tumbled.
“Emerging-market economies with lower vaccination rates, weaker external and fiscal balances like the Philippine peso, Thai baht, Indonesian rupiah, Indian rupee are likely to be at some risk,” said Wai Ho Leong, strategist at Modular Asset Management in Singapore.
More “tech-sensitive” currencies such as Korea’s won will also come under pressure given the selloff in the U.S. sector, according to Mitul Kotecha, strategist at TD Securities in Singapore.
On the fixed income front, DBS sees Thai bonds underperforming on a widening policy differential with the U.S. It likes Chinese bonds as a haven, where benchmark yields have dropped in the past month on expectations for loose monetary policy while all other Asia Pacific yields climbed.
“Thailand is expected to be one of the laggards on monetary normalization and therefore, a widening policy differential against U.S. Fed would weigh on Thai bond returns,” said DBS strategist Duncan Tan. “Indonesia bonds, being higher-beta, are typically more sensitive to increases in U.S. rates, although any weakness will likely be contained due to better defenses this time around.”
Stock Bets
Bets on equities are more varied.
In Japan, higher long-term U.S. yields should have a positive impact on the nation’s banks but become a drag on companies with operations in the U.S., according to Tomo Kinoshita, a global market strategist at Invesco Asset Management in Tokyo. Technology shares could also come under selling pressure, given their past relationship with yields, he added.
The MSCI AC Asia Pacific Communication Services Index fell to its lowest since June 2020 this week.
Small cap companies could become targets for short sellers as funding stresses from higher U.S. interest rates mount.
“The risk is palpable if the Fed is seen as tightening the screws too quickly,” said Ilya Spivak, head of greater Asia at DailyFX.
Morgan Stanley and Wells Fargo Say Great Stock Rotation Has Legs
Others are jumping on the opportunity to buy beaten-up names.
“I still like select industrials in Japan that are underappreciated beneficiaries in automation, electric vehicles etc,” said Joshua Crabb, a portfolio manager at Robeco in Hong Kong.
For HSBC Holdings Plc’s Herald van der Linde, Asia Pacific head of equity strategy, rotating into China and Indonesia makes sense because “valuations are low and we see good growth in 2022.”
High Yield
Heavily-sold emerging-market debt is also proving of interest to some as the prospect of higher yields to compensate for riskier paper lures fund managers.
“We are overweight emerging market high yield,” said Todd Schubert, head of fixed income research at Bank of Singapore Ltd. “The spread component also offers an adequate cushion against the adverse impact of rising rates.”
(Adds HSBC view in 20th paragraph, Fed tapering in fifth)
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