The world as we know it changes in front of our eyes. As all financial markets are interconnected, what happens in one market strongly affects the price action in others.
For example, the stock market has a direct influence on the USD pairs via a risk-on trading environment. More precisely, every move higher in the U.S. stock market makes is followed by a USD move lower against developed markets’ currencies.
The Desperate Search for Yield
Markets have changed dramatically. Ever since the Great Financial Crisis of 2008-2009, the financial landscape shifted due to central banks’ improvisations.
Unconventional monetary policy decisions (e.g., quantitative easing) sent the bond yields lower and lower. Hence, investors used to rely on a constant cash flow stream from fixed income securities, suddenly had to change their approach.
From the moment that the coronavirus outbreak reached Europe and the United States, the yields on the most-wanted fixed income securities (i.e., U.S. 10-year Treasury) started to fall. Timidly at first, from around 1%, until they recently dipped to negative 1%.
This is not a new development in the fixed income market. After all, the Austrian government had tremendous success selling century bonds with a negative yield recently.
But the Austrian bonds are peanuts when compared with those of the U.S. The world’s largest fixed income market suddenly sees capital fleeing due to negative yields. So, where is the capital going?
Surprise, surprise – China.
The Chinese economy, together with other Asian economies (e.g., Vietnam, Taiwan), are the ones projected to grow this 2020. Moreover, the Chinese 10-year government bond yield is a positive 3%. Hence, investors in search of a higher yield suddenly have something in sight.
Sure, there is the currency risk at stake – the Chinese Yuan is not the American Dollar, the world’s reserve currency. But July alone attracted an inflow into the Chinese bonds bigger than $20 billion. And rising.
To buy such bonds, one needs to sell the local currency (i.e., USD), and convert it into the Chinese Yuan. Hence, developments on the international fixed income markets explain part of the decline in the USD as investors around the world flee the American fixed income securities.
What next? China entering the global bond scene is an event big enough to shift markets without a pandemic helping it. Until now, what was just gossip, suddenly became a reality.