Understanding US Treasury & Yields

Just when the whole world coming for a rout, only US treasury yields shoot up to multi-months high. Investors might wondering why this happen. Some of our readers are posting these kind of question to us. We think this article might helps.

US Treasury = US Government Bond

Actually, we are referring to US Government 10 Years Bond. Generally, a government bond is issued by a national government (in this case US) and is denominated in the country's own currency (USD). Bonds issued by national government in foreign currencies are normally referred to as sovereign bonds. The yield required by investors to loan funds to governments reflects inflation expectations and the likelihood that the debt will be repaid.

Also, government bonds were usually referred to as risk-free bonds, because governments could easily devalue their currencies or raise taxes to redeem the bond at maturity. 

The Story of US Treasury Yields...

Just like Base-Lending-Rate (BLR) for Malaysia, everything from mortgages to corporate loans in US depends on US treasury yields. Higher yields mean higher borrowing costs. To stimulate the US economy, Federal Reserve had came out with various Quantitative Easing (QE) actions to bring down the said yields, allowing borrowers access to cheap funding. How to bring down yields? Federal Reserve will buy back US treasuries, thus, flooding the market with money. The side effect was a weakening USD.

However, all things will change 360 degree, if Federal Reserve start to slow down or totally stop their so called QE3. This is what happening now, creating uncertainties to global markets.

Why Gold Behave Differently this Round? (May 2012)

When market sentiment was bearish, equities market would slump, just like what we seen for past few days. Global markets suffered yet another blow due to the uncertainties surrounding EU, where Greece may potentially exit European Union. Would Greece finally exit EU? This is an interesting yet important questions for investors.

The headlines have been on the EU crisis recently, overshadowing the highly speculated Malaysia general election's date. Well, now would be a tough time for our Prime Minister to call on an election amid the gloomy global outlook. Maybe, the best time to hold an election already gone!!!

Anyway, another interesting issue was the slump in Gold prices. Curiously, many investors questioning the different trend for gold prices. Normally, it will spike up along with the risk level of global equities market, together with USD. Theoretically, gold and USD would over-perform other asset classes during bad times. Yes, USD had already appreciated against a basket of currencies for a record 12 straight days. However, bullion erased its 2012 gains this week while investors are reducing gold holdings for a 3rd month, the longest stretch since 2004.

So, which is the Safe Heaven now?

Based on that fact, it seems like USD is the only safe heaven asset class that investors trusted now. Frankly speaking, Finance Malaysia don't know why gold behave differently this round. Anyway, we came out with the following potential explanations:

1. Actually, we really don't know how to value gold. Is it expensive or cheap? There is no benchmark on gold prices. Because of that, gold price tends to be speculative in nature. Currently, hedge funds are the least bullish on metal since December 2008, and they are the one who drove up gold prices. Is this the time for them to take-profit?
   
   
2. While there is no benchmark for gold, the strength of USD was based on US economy. We can't deny that US is recovering now, amid at a slow pace. Also, without QE3, why USD should stay low? With that reason, investors might chose USD than gold, as the potential is greater.
   
   
3. Please don't forget that many European governments had the greatest gold holdings in the world. For sure, ECB needs to pump in more liquidity into market. Where does the money comes from? When you're holding many gold and you need money, what would you do? Of course, cash in by selling your golds.

Even said so, many analysts are predicting a rebound for bullion. While RBS, ABN Amro and Barclays cut their gold forecast in May, Goldman expects prices to rise by 25% to $1,940 an ounce in 12 months. Billionaire investors, George Soros is favoring gold and he may gave gold investors the confidence. Good Luck.

Why Gold Price DROPs lately? (Oct 2011)

During market uncertainties, there are two popular safe assets which is Gold and USD. This explain why the demand for these two assets is great, resulting them to become more valuable while equity market fell. We experienced the said scenario recently and let's see the chart below to gauge the Gold price movements.

"Gold prices collapsed from their August highs in September amid a broad commodity sell-off and despite intensifying concerns over sovereign debt issues in Europe. After exhibiting a remarkable correlation to real rates this year, particularly during the swift August rally, the sharp pullback in gold prices occurred with real rates mostly unchanged."

"Gold prices have now fallen back in line with our 3-month price target. As we expect gold prices will continue to be driven in large measure by the evolution of US real interest rates and with our US economic outlook pointing for continued low levels of US real rates in 2012, we continue to recommend long trading positions in gold and reiterate our 12-month price target of $1,860/toz", reported Goldman Sachs.

Why is it different this round?

Supposedly, gold prices should move in-line with USD. But, we see USD strengthening to months high while gold prices faced some setbacks lately. We at Finance Malaysia would like to guess the off-the-screen factors such as...

First, who is holding the most gold?

Second, who is in dire needs to sell gold reserves?

Of course, European countries (highlighted in yellow)

Now, you know why gold prices behave differently? Ha...ah. We are not surprise by the sell-down (if any), given the high valuations gold fetches when it recorded all-time high almost every days until $1,900/toz. Does Gold more important than cash right now? Yes for China, No for Europe.

US rating cut: Should we buy now? (9 Aug 2011)

To answer that million dollar question, please let us examine the whole situation. First, what actually caused the market to slump? Second, the correction is short or long-term? In the end, it depends on how gut are you as an investor in this sentiment driven market.

What actually caused the market to slump?

Panic selling is my answer. Simple and straight to the point. Investors are so scared that they can't figure out what is going to happen after S&P downgraded US long-time AAA rating. This was the first time US was being downgraded. No previous record for investors to forecasts, so dump first la. Herd mentality is playing a very crucial role now (again).

Short or Long-term correction?

As mentioned, panic selling also means short-term correction. People are throwing their assets at a discounted price for the sake of getting their sleepless night away. After awhile, then only they realized that the actual situation is not as bad as they think. Then, investors will come back to the "playground".

The panicky Good news?

While bear market set the stage last week, US did reported a few surprising announcements as below:

1. unemployment rate fell slightly in July to 9.1% as compare to 9.2% in previous month


2. payroll salary is increasing again in July (boosting consumer spending going forward)


3. 2nd quarter corporate earnings are better than many analysts forecast


4. After all, only S&P cut US rating while Moody's and Fitch still maintain the AAA rating


5. Commodities price came down so much which would put less pressure on inflation

Despite the good news, seems like the market was conquered by negative vibes successfully distributed by S&P. Finance Malaysia believes the market will sooner or later realized that the world economy is actually still recovering, albeit slowly. Investors will come back again in medium term owing to a few catalysts to rejuvenate investors' sentiment. Who knows QE3 is in the making?

Disaster after US rating downgrade? (8 Aug 2011)

The news that S&P downgrading US credit rating shows that rating agencies are doing their job fairly. Previously, rating agencies were blamed by Greece and Europe countries for downgrading their ratings when Greece facing rising debt issue. Though, US did not spare this round when S&P downgrade US AAA rating to AA+ (one notch lower).

What would be the implications?

Normally, the downgraded currency will slump, sovereign bonds will become less attractive by carrying higher degree of risk, hence pushing up the yields. Does US follow these theory? NO.

Why US is different?

USD will not fall much like Euro. First, USD is one of the safest asset, along with gold, during economic uncertainties. That's why USD was chosen as the world's most widely traded currency. During uncertainties (like now), investors are scare and they pull-out from equities around the world. But, where did they put the cash? USD is the answer mainly because it is widely used globally and of high liquidity.

Bond Yield will not jump like Greece's. Second, when the demand for USD is still there, US treasury bonds' yield will remain (or even fall). Continuing from previous question, where would you place your money, if it must be denominated in USD? Treasury bond or Cash Deposit? Definitely treasury bonds which still can give you around 2.5% yield (10 years US treasury).

The remaining AAA rated currency by there of the largest rating agencies.

How is the currency market would be?

Finance Malaysia believes that USD will weaken against major currencies which were rated AAA, but will strengthen against other non-AAA countries (including Malaysia). You may refer to the table above to gauge which currency should perform better in the near term.