It's difficult to tell if we’ve reached any significant inflexion points, but it's certainly starting to feel that the rip higher in US bond yields, at least on the margins, could be a match to the stimulus powder barrel.
US equities were little changed Tuesday, the S&P up 0.1% heading into the close. Another big sell-off in fixed income; however, US10Y yields were up 9bps to 1.3%. Oil was up 0.8% to remain around 13-month highs. Simultaneously, the US output gap and inflation remain at the centre of virtually all market debate.
The reopen and reflation trade continues to outperform – and it’s no surprise to see banks and energy in the lead. However, the long growth and momentum trade is fading; there was plenty of red on the tape as those sector investors are getting antsy about higher US yields.
Still, for the most part, investors remain reassured by expectations of another round of US stimulus and ongoing support from the Fed. Critical in the narrative is that the House Democrats must keep pedal to the metal on the reflationary bus as the market hopes for a swift and sizeable fiscal package is equally on maximum overdrive. US Fed rhetoric has been keen to downplay tapering talk, and the FOMC minutes from the January meeting are likely to repeat this tone.
Retail sales, released later today, will be this week’s marquee US data point and it would be a considerable understatement to say there's a concern in some corners about the US consumer. The January jobs report suggested the services sector remains mired in a recessionary wet blanket, even as ADP and PMIs send conflicting signals. So, an upbeat US retail sales report could provide the all-encompassing "proof is in the pudding" that investors need to take the next massive leap of faith.
Structural reflation remains the most likely path forward as populations are increasingly inoculated and US fiscal stimulus expectations crescendo into March. Meanwhile, central bank policy normalization will likely become the next theme of focus in sequencing events as Powell has done too well a job of lulling the market into a sense of complacency, ironically planting the seeds for a taper tantrum scenario.
At what point will rising yields upset the apple cart?
With 10yields above 1.3% and WTI above $60 now acting as a recovery drag, the risk outlook is becoming more treacherous and could be why the S&P 500 is floundering this morning. It's difficult to tell if we’ve reached any significant inflexion points but it’s certainly starting to feel that the rip higher in US bond yields, at least on the margins, could be a match in the stimulus powder barrel. That being said, it remains to be seen if or how any real drags will hinder the raging bull driving equity market sentiment these days.
The move in rates has been swift and ferocious as the market has rightfully shifted focus back towards improving data, progressing vaccinations, fiscal stimulus in the US, and a Fed intent on reflating the US economy. Inflation expectations can act as a positive impulse for equities but are nearing levels where they became a headwind or, at minimum, cause investors to pause for a more in-depth look at all the reflationary headline noise.
While it isn't time yet to flatten reflationary risk altogether, it does appear some investors may be reducing some stock market beta risk in the face of skyrocketing US yields. But this is not just US yields rocketing; there’s a move afoot globally, suggesting that future monetary policy implications are getting priced into the curve at some level, making money flat out more expensive along the curve.
Look at the wires and the headlines on screens and the message is: "reflation trade." The memo gets passed accordingly, but there’s a reason why gold is trading below $1,800. US treasuries aren't necessarily reflecting a "reflation trade" well – and certainly not on this latest yield’s swift runner. Of the 9bp gain in the 10-year yield, only 3bp is from inflation expectations. The other 6bp is from real rates. It's not term premium that's rising, it's the actual hard cost of money.
Back end Euro-Dollar futures and treasuries are re-pricing the Fed. Still, nothing out to the end of 2023 can shift – unless one wants to bet against near-term Fed guidance. That's why 2-year treasury yields are in check at 12bp and the front of the Euro-Dollar strip is all but unchanged. But after that point, things start to unravel quickly as it’s turning into OPEN season on bond desks from Sydney to New York and everywhere between.
For the most part, stocks are shrugging this off the treasury, perhaps viewing the recent yield jump as an extension of the reflation theme, while lifting all boats tied to economic growth and stocks that look attractive to global price pressure points. At the same time, retail traders – many of whom don't understand the difference between real and nominal yields – continue to ride the wave of speculative bliss on virtually every momentum asset spurred on by social media influencers.
Looking at the market flow and a thinly bid yield curve, treasuries are far from considered cheap at this level as no one wants to stand in the way of higher yields, suggesting the move has much further to run. At some point the markets could eventually notice that yields do not reflect a cyclical uptick, but rather central bank policy pivots. But, from my seat, it looks like we’re going full circle back to mid-Jan taper tantrum trade and all the while markets have seemingly "back shelved" the topic of the Biden administration’s tax hikes.
The USA's ongoing power crisis continues to support oil, with freezing weather boosting energy demand and disrupting supply in key producing regions; the perfect storm for oil bulls, if you may.
Crude prices are hanging on Monday’s rally as the US's cold snap continues to play havoc with domestic energy markets. By its nature, snow in Texas is a temporary thing and it will reverse as quickly as the weather patterns change. Today, oil is trading lower and the stronger US dollar is gaining a head of steam for US yields which are stepping up to challenge the bullish reflation momentum.
Still, this is one of the worst of Mother Nature’s catastrophes I can remember in terms of catching the oil complex wrong-footed at the supply levels. Many of Texas's refiners remain shut and, putting things in perspective; it's at the double the number closed during hurricane Harvey (roughly 5mbd), implying a colossal gasoline and diesel fuel loos while setting the stage for a healthy gear up for the summer driving season as refining margins have soared.
Although the storm is turning into a human catastrophe, it provides another two or possibly three "look through" weeks as the markets continue to increasingly view the Covid-19 northern hemisphere winter of despair through the rear window.
OPEC sources have told Reuters that the rally in oil of late makes it more likely to further ease supply curbs after April. The sources said as that, things stand, the market might be able to cope with another 500kbpd. But it's hard not to expect even more of the same coming.
The focus will soon shift to the OPEC+ meeting taking place in early March. It will be necessary for the group to continue to present a unified front and convey the impression that it is still enforcing supply discipline. I suspect behind-closed-door discussions will focus on adding more oil back into the market without upsetting the proverbial apple cart. Higher oil prices in themselves can be a drag in the global growth narrative, especially for the substantial consumption engines in Asia (India, China, Korea). Right now, they’re only getting a fraction of relief via the weaker US dollar.
Soaring US yields provided the game-changer for the US dollar momentum overnight. And the US dollar certainly took kindly to the Fed’s James Bullard who, on the eve of the FOMC minutes, says he expects a "roaring" US economy that could even outpace China.
USDJPY soared to 106 and, after the USD rally took a bit of a hiatus in the London morning, as New York walked in after the long weekend they started selling USTs and furiously dragging the greenback to new highs of the day. Accordingly, there’s a sharp sell-off in EURUSD. Expect the USD move to continue as rates seem to have more room to run.
Oblivious to higher US yields and Asia FX risk – which is taking a step back after media reports saying that China is looking at ways to "hurt US defence contractors" by limiting its exports of rare earth minerals (used in components of high-tech devices) – the ringgit was on full steam ahead mode on soaring oil prices while getting support from stock and bond market inflows as Malaysian capital markets start to shine again as MCO gets lifted.
However, today I expect higher US yields to weigh on sentiment which should encourage some profit-taking on the MYR.
Much of the gold market current woes are attributable to rising US yields.
With the pace of US vaccinations accelerating, continued signs of recovery are beginning to give the bond market jitters about inflation/taper and issuance profile for the rest of the year. TIPS are starting to experience selling across a vast spectrum.
For more market insights, follow me on Twitter: @Steveinnes123
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With markets relatively quiet ahead of the FOMC meeting, eyes turn towards exotics; Global equity markets continue consolidating; Oil prices extend gains