Australia dollar signalling taper tantrum 2.0?

From Credit Suisse:

As we highlighted way back at the end of July – Lift-off for 5yr US Yields – we have viewed the 5yr US as pivotal, as we believe a break here can act as the lead indicator for a more broad-based sell-off for US bonds. Although we were clearly too early at the end of July for this call, we have now seen US Duration Risk Appetite move to “euphoria”, as well as maintain its momentum sell signal, and we may finally be on the cusp of an important break.

Above 1.865% should finally mark the completion of a large “triangle” continuation pattern. We would expect this to act as the catalyst for what we believe could be a rapid move higher in yields for 1.99/2.00% initially, then our 2.33/43% long-held target – the 38.2% retracement of the entire 2007/2012 decline in yields and 2011 highs. While 1.865% caps, yet again, the trend can stay firmly sideways.

The five year never retraced its 2013 taper tantrum losses the way the 10 and 30 year did and it sure does look like it’s poised for break down amid the chatter of coming US interest rate rises. I still see Q2 next year but that’s only six months away so markets are really discounting that outcome.

That brings us back to my thoughts of several weeks ago:

Last year’s spectacular “taper tantrum” in markets is something of a misnomer. It was an episode of “risk off” behavior driven in part by the Federal Reserve move to begin tapering quantitative easing (QE). US bond yields suddenly soared as higher interest rates became an expectation. That saw capital repatriated from emerging markets economies to the US and, as the MSCI emerging markets (EM) index shows, equity was hit hard (so was debt and forex):

But there was another very important factor in the tantrum that is usually forgotten. The timing coincided with a sharp slowing in the Chinese economy after its 2012 round of stimulus (which wasn’t that “mini”) and that set up a feedback loop for markets to rush out of EMs because they are very China export dependent. Couple that with the withdrawal of capital that had been chasing higher interest rates in developed economies and you had a near perfect storm in EM external balances.

Markets have since recovered handsomely owing to two changes. The Fed managed to convince markets that tapering was not tightening and the backup in bond yields stopped (and has been reversing ever since). Secondly, China launched another mini-stimulus and turned its economy back to growth quick smart.

The stimulus kicked the can for about 8 months and then another kick was required three months ago. Now that kick is also waning, much faster than even I expected, strongly suggesting that each kick is less effective than the last.

More importantly, China is going to slow further under pressure from housing. We’ll no doubt see more targeted stimulus but it’s a losing battle while housing falls. There is no “recovery underway” nor coming. This is a structural adjustment to slower growth that is being managed down using bouts of fiscal spending.

And so it has transpired and authorities are still reticent to introduce stimulus.

If the US five year breaks out with another nudge or two from the Fed and China holds the line on stimulus, taper tantrum 2.0 is go. It will be smaller than last time given the improvement in many emerging market external accounts but it will be big enough to cause serious risk off for equities and take the Aussie down hard, the leading edge of which we may already have seen…