US equities were lower Thursday as the S&P headed down by 1.5%; losses were led by tech, with the NASDAQ down 3%. The bond selloff has extended further post-Fed, US10yr yields lifted 7bps to 1.71%, the highest level since 23 January 2020. Oil fell 7.1% on a combination of short-term demand and longer-term supply concerns.
The rapid rise in long-end US yields has spooked investors again overnight as there appears to be no lasting respite for the fixed income onslaught. Given the untimely and ferocious nature of the selloff, which caught some investors wrong-footed whilst cheering the FOMC "lower for longer" mantra, it caused a real stinger to longer duration growth asset sentiment like mega-cap tech names.
FOMC experiment failing
The Fed's experiment isn't working, as the market is finding in the aftermath of the latest FOMC meeting. Indeed, this is because of the market's expectations around the forward path of economic data. A dovish stance only increases the inflation risk premium's sensitivity to the economic upgrade in a market state where fundamentals are expected to continue improving.
The two paths as we advance are:
The issue with #2 is that there’s still a long runway of catalysts from stimulus and vaccine tailwinds, so it may be a while before the market can confirm or deny its positive outlook on economic data. So, that cat and mouse game looks to be a 6-12 month story, at least.
The fear of falling behind the curve (the next "Wall of Worry")
With the Fed already forecasting a pickup in inflation – and assuming it will be transitory – a policy mistake here, if it happens, won't be rectified until it's way too late in the game, which will mean faster hikes and a market meltdown.
The market risk is not that the Fed is not dovish enough in pushing back on the rise in yields. It’s instead that the Fed is at risk of falling behind the curve. Bonds reacted to Fed Chair Powell's comment that upcoming inflationary pressures would come from base effects and the potential surge in consumer spending as economies reopened. But even with inflationary pressure coming for improving fundamentals, the Fed would still be biased to question whether it was only transitory. While the Fed could be correct, this always heightens inflation risk premium if they’re wrong, and the higher it goes the higher that risk becomes.
US rates and bonds traders took the Fed to be much less dovish than headlines initially suggested. With several FOMC members breaking ranks with the central message (seven see higher rates, and the more hawkish are pushing their dots further up) a conclusion to be made is that it wasn't a "dovish Fed", but rather one that was agreeing with the market that there's a rising possibility of rates moving sooner.
Equities are the glue holding current trends together; as long as risk assets remain resilient, nothing will stop the market from repricing fixed income yield higher.
What started as a profit-taking correction triggered by a vaccine health scare has now moved into a whole price level correction. The selloff is getting compounding by risk-off moves in cross-asset correlations as the market continues to price in tighter financial conditions, despite the Fed’s effort to suggest the contrary.
Because of very patchy reopening – with most countries outside the US, the UK and Israel, behind in their vaccination rollout protocols and even some countries in Europe back in lockdown – frothy oil market sentiment is catching down to the short term economic demand reality.
Oil is down 7% today. There’s little in the way of oil specific headlines to support the move, rather a softening in the demand expectations and a strengthening of the dollar spurring some caution in a market that’s quite long in terms of speculative positioning.
And despite what’s happening in Germany, France, Spain and Italy, it will recommend using the AstraZeneca vaccine after the European Medicines Agency deemed it "safe and effective.", the oil market shrugged, leaving oil bulls and analysts scratching their head and wallowing in a world of hurt.
But, at the heart of it all, the rally was mainly on the back of OPEC+ production cuts – or rather the fact that they agreed to hold production steady in April instead of ramping up production as the market had anticipated. So, I suspect the oil market is experiencing a bit of reality check these days as the super-cycle bulls might be giving way to the power of spare capacity as the thought of more barrels coming back continues to provide the medium-term supply headwind.
And do watch out if the China credit cycle starts to rein in commodities.
The USD has reversed after a modest selloff in the wake of the FOMC meeting. The Fed conference outcome was expected, but the 2023 median dot continuing to signal no change in policy proved a sufficient catalyst for some USD selling in a market overly obsessed with "dots". Still, higher back-end yields overnight (10-year UST yields are above 1.7%) have modestly seen the USD firm.
The forecast revisions read like an unexciting novel, basically bringing the Fed into line with a market consensus that has materially upgraded its US growth expectations over recent months.
There was no announcement on the supplementary leverage ratio (SLR) exemption (Chair Powell said it would happen in the coming days), so there wasn’t a great deal of drama for yields or, by extension, for the USD this front. But it is keeping traders on the guessing chair and bringing FX trading to a bit of a halt in the New York session.
It's not US yields up, USD up – it's more nuanced than that
Yields and USD are up this morning, but it's worth keeping in mind that it’s relative rates driving G10 FX, not US rates. We keep going round and round with the yields up, USD up thing, but in the end I think commodities, stock flows and relative rates are more important than US yields in isolation.
As Canadian yields have been going up faster than US yields, a rising yield environment has been USDCAD negative.
Asia FX never responds well to higher US yields where local traders are buying the dollar dip mode. Despite short-lived positive mood changers like this week’s FOMC meeting, the medium-term thinking around higher US yields is holding local currency bulls at bay.
With oil prices tanking and US yields shooting higher, it should prove to be a near-term toxic combination for the ringgit that remains tethered to the US rates market proclivities.
After surging higher in the aftermath of the FOMC meeting and Fed Chairman Jerome Powell's press conference, gold and silver eased but retained a sense of firmness with limited losses as gold found stronger hands with moves below US$1,720.
Essentially gold was hit by a recovery in the USD. The USD reversed losses in Asian and European trading after Wednesday's modest selloff in the wake of the FOMC meeting. The key to USD strength – and gold weakness – was the rise in higher back-end yields. The US 10-year Treasury yield pushed back above 1.7% could keep the pressure on gold if yields continue to break fresh higher ground.
Gold's decline since the start of the year is consistent with a growth recovery story in which bond markets adjustments imply a rise in risk-free yields and unwind of safe-haven investment holdings.
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Sometimes you have to throw conventional wisdom out the door and just let the good times roll