Equities got hit with the inflation stick Wednesday as technology shares felt the bond market vigilantes’ wrath after another spike towards 1.5 % in US 10-year bond yields.
The sell-off in global fixed income markets is revving up again, spilling over to unseat equities and other relatively heavily positioned risk-sensitive assets. Investors were left agog at just how soon the market is already testing the central bank policy thesis.
Chicago Federal Reserve Bank President Evans today did not push back on the rise in yields. He said he does not see a risk of inflation rising too quickly and does not think the Fed will need to change the duration of QE purchases.
To my mind, the only thing left that might influence the Fed’s decision-making process would be whether financial conditions were to tighten or markets were deemed dysfunctional.
To convince the Fed that markets are dysfunctional, I suspect it will take a lot more than 4bp tail in the 7y auction or 2013 styled velocity increase in the US 10-year bond yields.
Still, with financial conditions forever too loose, Fed intervention’s hurdle is high and will be higher always when activity and inflation data come in very strong through Q2.
Prospects for a rapid recovery in US consumer spending are increasing after the White House announced on Tuesday that it would have enough vaccines for every adult by the end of May, two months earlier than previously reported, which leaves the consensus forecast for 2021 US GDP growth of 4.9% much too pessimistic.
With the US economy about to shift into maximum overdrive, GDP could hit 7.5%-8.5%, buoyed by the vaccine roll-out and pent-up spending to come in Q2. So to any trained eye, real yields far too low ahead of a decisive period for economic growth.
The market focus remains worryingly on higher interest rates, a by-product of market-based inflation expectations, as well as the throughput effect into the heavily owned tech sector, where alarm bells are sounding amid lofty valuations.
Navigating inflation euphoria is no easy task as commodity base effects, fiscal stimulus, and reopening coincide. It will be difficult to fight inflation enthusiasm and even more problematic for FX markets, as monetary and fiscal policy differentiation tends to be more pronounced heading out of a crisis than when during a financial emergency.
Still, until a clear top lid gets put on bond yields, rate jitters amid higher volatility are going to be the order of the day.
The Fed should not be in a rush to lean against higher yields, interpreting the rise as being justified by endogenous drivers like building optimism around the economic recovery. So, the Fed could willingly leave it up to the markets self-correcting mechanism (higher bond yields) to ease sentiment back into the risk parity level where both higher bond yields and stock markets can exist in perfect harmony.
I guess we will remain in the bond market churner where rates go higher, and it is scary when it happens too fast.
Still, higher rates are fundamentally good economic news and a natural by-product of a rebound out of financial crisis and into normalcy and reflation.
Whether higher rates are good for stock indexes stuffed full of long-duration higher flyer bit-tech is one question. In contrast, WFH tech plays are another as we near the selling window for profitable day traders who need money to pay for April 15 tax obligations.
Oil prices jump
Oil prices jumped early on Wednesday, following reports that the OPEC+ group could be contemplating the possibility not to increase collective oil production from April as widely expected.
What started as a calm trading day quickly turned into the running of bulls after it was reported that the OPEC+ alliance is considering to keep the oil production cuts from March in place in April and given the still-fragile global demand recovery.
There was a massive build in oil stockpiles for the week ending February 26. After the freeze, a build had been expected but not entirely of this magnitude – it was the largest build since 1982.
But I think framing out the bullish vibe are the unambiguously positive recovery headlines around reopens and vaccines in the US.
The OPEC+ meeting today hinges on the gap between Russia’s preference to add 1.5 million barrels per day of crude oil production and Saudi Arabia’s choice for adding 0.5 mbpd.
Perhaps more interesting is the lack of response of US shale to the higher crude oil prices. Historically US shale has been the fastest to react, but some cold water was being poured on this by Occidental, which envisages shale production never recovering to pre-Covid-19 levels.
Oil bulls also bullishly point to an increase in output from OPEC+ being a reduction in spare capacity.
However, it seems likely that just as low prices were the cure to low prices in 2020, there is not much appetite from a recovering global economy for materially higher oil prices in the near term. So, the OPEC calculus is a challenging one.
Market analysis and insights from Stephen Innes, Chief Global Market Strategist at Axi