US equities traded mixed on Monday, the S&P down 0.1% heading into the close after paring earlier gains. There was a more decisive outcome for the Dow (up 1.5%) while NASDAQ fell 1.8%. US10Y yields rose a further 2bps to 1.59 %.
Investors are considering the tail risk consequence ahead of this week’s treasury auction supply, with signs pointing in the direction of another painful week for bonds. As a result, the stock indexes diverge as the rotation theme picked up steam throughout the day.
While rising US bond yields are crushing the high valuation mega-cap tech stocks on the NASDAQ, improving activity data and positive vaccine news are making investors extremely comfortable in lapping up value stocks, suggesting that not all equity counters are created equal for this phase of the economic recovery.
It's still very much a stimulus-induced rally and rotation in US equities. Yet, until US yields stop rising, investors will continue to shun any longer duration assets and tech stocks might continue to roil under the heat of higher rates.
In the eyes of the market, tech stocks' long-term earning power had become more and more valuable when discounted at lower and lower interest rates. Now that that shoe is getting put on the other foot, tech stocks are becoming less and less valuable when discounted by higher and higher interest rates and no different from 10-year bonds.
Now that sentiment and policy circumstances are changing, so will the calculus that props up both asset classes (bonds and tech). If inflation comes about – or instead looks a realistic possibility – you won't see buyers of government bonds or tech stocks for dust.
It's been a hectic few weeks for markets, driven by the increase in DM sovereign bond yields. But for all the talk about a bubble in equities or an increase in profits prompting a wave of selling in risk assets, the stout performance has probably been more surprising to the bears than bulls.
Oil prices fell on Monday, hours after an early sharp price rise caused by a drone attack on Saudi oil infrastructure missed their mark. There’s also been a change in the mood music over the past 24 hours as oil fell on the back of a stronger US dollar. Traders also came to terms with some of the NPC takeaways that revolved around less credit and stabilisation in Chinese markets' leverage.
All the while, higher US yields continue to tighten financial conditions tempering the reflation trade, triggering more profit-taking from cross-asset players that were using oil as a speculative reflation hedge.
But fundamentals remain incredibly supportive, especially with Saudi Arabia in full control pursuing a tight oil policy. Brent is currently holding up above $68, suggesting speculators are likely dipping their toes back in after yesterday’s chaos.
Meanwhile, the US production response to higher prices remains inelastic, with the Baker Hughes rig count reported up only +1 on Friday. However, the frac spread count does continue to rise more quickly, suggesting the industry is pulling down on its DUCs, accessing the higher prices in a capital-efficient fashion. Whether this leads to a more significant response from shale, only time will tell.
Perhaps more significant for oil in the medium term is growing evidence that the US and Iran may revisit the nuclear deal that fell apart when former US President Trump unilaterally withdrew the US from the agreement. In an interview with the FT, Moshen Razael – a potential Iranian presidential candidate and former leader of Iran's Revolutionary Guard – said Iran would be ready to resume talks with the US and other Western powers if given a "clear signal" that US sanctions would be lifted within a year.
If progress veers towards the positive, Saudi Arabia will likely increase its production rather than lose market share to its geopolitical competitor.
Elevated US yields are the primary catalyst for market moves overnight, including the stronger USD. While not rising precipitously further overnight, US 10Y Treasury yields remain lofty, hovering around 1.60% as the US makes further progress towards the massive fiscal stimulus. The Fed rhetoric suggests it will stay on the sidelines amid the economic recovery.
High yields seem to be proving a challenge to some pockets of the equity market, with notable weakness in the tech sector evident in China's markets yesterday and US Nasdaq futures overnight.
For the USD, the repercussions are so far proving doubly supportive. Higher yields echo the narrative of US exceptionalism and USD yield advantage, while weaker equity markets provide the USD with a haven bid.
The stairs up and the express elevator down typifies the last two weeks in the gold market.
The US economy is doing much better from a growth perspective than many had expected just two months ago. In particular, 'hard' activity data have surpassed consensus expectations lately and have been the driving force behind bond yields going higher, much to gold investors’ chagrin.
The US yields traded to their peak for the year and the dollar touched its highest in three months, sending gold prices reeling. The interest rate pressure is likely to be a more extensive and nearer-term factor rather than the positive force of expected inflation, suggesting gold may head lower when interest rates shoot up again.
This week's US bond auction and supply present a clear and present danger for gold investors. Buckle in if the auction results tail poorly as it could be a reasonably steep drop for gold prices.
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US equities continue to welcome any high-risk event being put in the rear-view mirror – especially when rates markets look prime to consolidate lower