The bond sell-off extended further overnight, with US10yr yields up a whopping 17bps to 1.54% – the highest since February 2020. Those moves prompted equities to sell off as well, led by tech stocks; the S&P was down 2.3%.
With discussions amongst the Democrats pointing to as much as 3trillion in infrastructure spending and the pandemic continuing to normalize, bond traders wasted little time pricing in a hyper-stimulated and inflated return to normalcy, triggering massive sectoral dispersion with technology stocks under the hammer given growing valuation concerns. Tech stocks are susceptible to rising yields because their value rests most heavily on future earnings, which get discounted more negatively when bond yields go up.
Markets ignore financial stability favouring inflation hedging and are getting quicker to cast a critical eye on central bank guidance. High beta US/EM is up, and The Street was speedy to fade yesterday's buy-the-dip with US bond yields moving through US tech sectors like a wrecking ball. And with traders constructing analogues to the 2013' taper tantrum', which saw global asset prices and currencies tank just in anticipation of a tapering of the Fed's asset purchases, of course, this made investors wary. Just how stealthy the early stages of this taper tantrum can remain have yet to be seen.
Tech investors continue to run the gauntlet of higher yields and less compelling valuations, with the bond market signal screaming at investors to trim some overweight tech. Since early 2018, a rise in the long bond yield has sent risk tremors through the stock market on four occasions: February 2018, October 2018, April 2019 and January 2020; during all four events, the turning point was the narrowing of earnings yield premium on tech stocks due to rising 10-year US yields. Pressingly, as US bond yields continue to march higher, this continues to suggest the heavily weighted tech sector could be on the cusp of a very unpleasant near-term valuation test.
With real yields having bottomed and in the process of moving higher, 2013 may be the most likely analogue for markets at the moment. And while it doesn't fit perfectly given we’re in the midst of a never before seen type of economic recovery, one thing seems clear: with more stimulus to come and the pandemic continuing to normalize, this time the market may not wait for the Fed's signal to price the eventual pullback in monetary accommodation. And while rates have come a long way, the level of 5y5y OIS indicates the process is not finished yet and there’s still room to move higher and trigger a deeper tech sector correction.
Economic data will need to carry the reflation load
Fed Chair Powell has maxed out his dovish messaging, so there’s little in messaging he can say short of action that will be interpreted as dovish. But, just as worryingly, real yields have now become a source of volatility for risk rather than a source of support. The next leg of reflation will have to be carried more and more by a continued recovery in economic growth, as fiscal and monetary stimulus is increasingly reflected in the price. And all the while this will bring the Fed closer to acknowledging that policy normalization will at least need to be discussed.
A stronger dollar, especially against Asia EM and higher bond yields, led to the selling of long-duration assets and, given the massive overweight of "long duration, infinite growth tech" at the index level, stocks are capitulating. And the domino effect is starting to hit commodities like oil, triggered by a correction in the reflation trade due to higher US yields that are becoming a significant source of market volatility.
Next week's OPEC+ meeting has more potential to be damaging than a positive catalyst, given the optimism now priced into oil and the likelihood the group takes steps that could prompt a round of profit-taking.
Still, any correction is likely to be short-lived given evidence of an ongoing demand rebound and the likelihood that oil markets remain tight this year.
The quick rewinding of risk-on mood music, triggered solely by higher US yields, sees the US dollar trading more robust this morning.
The UST 7y auction tailed 4.4bp as participants take a complete step back from buying bonds in this environment, setting the tone for the FX market overnight.
The higher yields are starting to exert a domino effect on commodities, and the widely held commodity linker currencies are feeling the higher US yields pinch this morning.
This taper's repricing is becoming less stealthy as the significant rise in yields is global, not just a US phenomenon. At this stage, the repricing is not aligned with Fed policy reaction functions. If that does become the case and US yields move head and shoulders above the rest, the dollar takes flight.
Although the yield being back up this week was more of a globally synchronized event, my main scenario still expects yields to be led by the US this year – especially with the enormous fiscal US package likely to be finalized in the coming weeks, which should continue to offer support to the US dollar.
US yields continue to climb and the US dollar is stronger across the board as a result. Oil is trading lower as profit-taking is setting in ahead of next week’s OPEC meeting, so we should expect the MYR to change hands on a defensive bias.
The rise in real yields has seen gold under pressure with everyone selling. Although positioning is cleaner, the overall market is still long and ETF selling is negatively, affecting the market on actual position clean-out rather than just speculative sell-off, which is more worryingly and an early sign of a capitulation.
But this morning, it’s a double whammy beat down with higher US yields triggering a strong US dollar response.
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Stocks soar, powered by first-rate earnings and a dazzling run of economic data; Gold plays catch as G10 falls flat while oil basks in the afterglow