One thing is becoming ever clearer; we are close to or have seen an end to the T.I.N.A (There is No Alternative) trade – The idea that bad geopolitical news, poor economic data, or some other macro news flow results in lower bond yields and a subsequent hunt for relatively higher-yielding assets, such as equities or high yield credit.
Market participants have enough complexity in their trading without having to assess how assets will react to news when often logic means little. So, the fact that bonds rally (yields lower) on bad news and subsequently we see equities trade lower, makes life a touch easier. The TINA trade is seemingly over, and the equity market is sensing a message from both from the bond market, which to be fair isn’t particularly upbeat right now.
If I look at the relationship between the S&P 500 and the Citigroup US economic surprise index, we can see an interesting correlation. I have flipped the S&P 500 to highlight the relationship, but as US data has come in slightly hotter than expectations in recent weeks, with the Citigroup surprise index (white) increasing, equities have still struggled.
The question is, why are stocks falling when data is coming in somewhat better and failing to rally when the data comes in worse? Well, firstly the flow into longer-maturity bonds has been relentless, as we can see here from the US 30-year treasury (white). The buying in the long-end has been one-way, with yields now at 2.14% and about to test the 2016 low of 2.08%, and as we can see US 30-year Treasury implied volatility has pushed to the highest levels since early 2018.
(White – 30yr Treasury, orange – 30YR Treasury implied volatility)
Equities are no longer rejoicing at the lower yield environment, in fact, with the Fed’s recent formal communication, detailing a bank that is still reluctant to ease for a sustained period, any positive economic data that threatens the four rate cuts that are priced over the coming 12 months is seen as risk negative.
With this in mind, keep an eye on US CPI due at 22:30 aest, with the consensus calling for headline CPI to push to 1.7% (from 1.6%) and core CPI to remain at 2.1%. The risks seem symmetrical, but the market will be sensitive to this, and from a simplistic perspective, a hotter number only reduces the need for the Fed to ease in September and this will be a headwind for equities. Put USDCHF (see below) on the radar with a weak CPI print likely pushing yields lower with the probability of a 50bp cut in September increasing from 31%.
With inflation on the mind, we can also see US five-year inflation expectations holding in at 1.80%, and until we see this instrument trending lower the market will demand more from the Fed, but they may not get what they want.
As previously stated, I think that while the Fed would be influenced by external factors, they are watching US and global inflation-expectations and financial conditions very closely. Neither variable, if we take these in isolation, are giving us any reason for the Fed to ease aggressively, and that in itself makes me feel caution is still warranted and the likes of gold, the JPY and Treasury’s, despite being incredibly well-loved, have further to go.
If I look at the S&P 500, it feels as though the risk is, we head back to the August lows and a re-test of 2820. I would expect the bulls to defend this area again, but that depends on the news driving at the time, and if I knew that news flow that was driving us into that support zone then I would share. If I look at the S&P 500 high beta index vs low volatility index (denominator) ratio, which is a good way of visualising how defensive stocks are outperforming the theoretically more riskier stocks, we can see this working in favour of defensive stocks.
We can look at the US 10-year ‘real’ (or inflation-adjusted) Treasury, yielding 4bp and, about to turn negative. We can see the US 2s vs 10s yield Treasury curve now a mere 5.9bp from inversion, with long-term yields lower than short-term yields. It’s obviously a global issue, with Australia’s yield curve (2s vs 10s) now at 19bp and at the lowest since 2010, with calls for inversion here growing by the day. Hardly a development equities are going to shine and further confirmation the T.I.N.A trade is waning.
The geopolitical argument is real and another reason why equities are failing to rally when we see any better data. Traders are currently treated to a whole barrage of negative themes. At the epi-centre is an ever-deteriorating US-China trade relation, with Trump putting on the façade that he’s happy either way if the talks take place in September. The narrative in local Chinese press is defiant, with calls they can “defeat any challenge”, and that the “US should not underestimate China’s will”. Talk is we could see China place new restrictions on exports of rare earths to the US.
We have developments in Argentina, which is weighing on EM, while Hong Kong is clearly a bigger market issue and we watch to see how this upfold. Traders are so short of GBP, with GBPJPY or GBPCHF getting taken to the woodshed and chopped up and we watch with bated breath at the reaction from Corbyn when the Commons comes back from Summer reassess on 3 September as a vote of no confidence seems almost inevitable.
Italian politics, or the woeful chart set-ups in the European banking, are also in the headlines, and it’s hard to see how any of these factors give us a belief the worst is behind us.
Published by Chris Weston, Head of Research, Pepperstone