We have had a lot of questions this week about inflation and the large spike in US treasury yields. Earlier in the week, we saw the 10-year US treasury yield hit 4.0% and then move back down to 3.73% in a single day. All of this was happening while the US dollar was also getting stronger. If people are buying the US dollar, you would think that the price of these bonds would go up, which would drive the yield down.

 

The chart below shows why US dollar yields are spiking so high. As you can see, central banks around the world are trying to defend their currency from going down against the US dollar. In Canada, we have seen the Canadian dollar drop from $0.77 on September 13 to $0.725 today. The Canadian dollar is normally one of the better performing currencies out there. Countries like the UK and China are selling their US bond holdings to buy back their own currencies in an effort to stop their values from going down. Add on the fact that the US Federal Reserve is doing quantitative tightening (selling US bonds that they own) and you have a sellers’ market in US treasuries. When people sell US treasuries, it makes the bond price go down which in turn makes the yield on those same bonds go up.

 

Source: China’s USD Reserves, Timmer, Jurien (@TimmerFidelity), “And, as you can see below, the People's Bank of China is busy defending the Yuan, and thereby depleting its US Dollar reserves). /END”, September 29, 2022, 10:56AM, Tweet.

 

HIGH INFLATION IS STILL DRIVING THE MARKET

We still haven't seen a steep drawdown in the inflation number. It appears that it has rolled over and is starting to come down, but the Federal Reserve is waiting for a more significant deceleration in the month-over-month rate. As mentioned above, the US dollar is significantly stronger which should also help lower inflation in the US. A rising US dollar will certainly slow down the economy but again this is a lagging indicator and will not be felt in the inflation numbers for a few more months. The next CPI release is October 14 which should give us a better feel for inflation.

 

With all this information in mind we are increasing our bond exposure once again. Interest rates have now reached a level that is much more attractive and offer a good opportunity to add to.

 

I have also included a piece from our CIBC Economics team entitled “Two’s company, 285 thousand’s a crowd".

 

As always if you have any questions please give us a call.

 

Have a great weekend.

 

Milan