The ‘bloodbath’ in global bond markets continued last week, with U.S. 10-year bond yields ending the week up another 7bps to 1.41%. A poorly supported U.S. 7-year Treasury bond auction appeared to be the catalyst for last week’s further yield gain, with assurances from Fed chair Powell (not even thinking about ending QE anytime soon!) only stemming the sell-off for a couple of days. U.S. 10-year yields in fact had a closing high of 1.52% on Thursday. The speed of the move suggests a technical/stop loss clean-out of many investors who had been picking up yield at the long-run of the curve – on the expectations that the long-rate would remain contained. They did get pennies for a while, but the steamroller finally arrived.
As would be expected, equities buckled further under the yield onslaught, especially growth sectors such as technology and consumer discretionary (CD). Helped by higher oil prices, the global energy sector managed a 2% gain, while financials (whose profit margins benefit from a steeper yield curve) only dropped 0.6%. Technology and CD dropped 4.7% and 5.6% respectively, making last week a decisive win for value stocks over growth.
Economic news, meanwhile, remained very encouraging (which also contributed to bond nervousness) with strong gains in U.S. durable goods orders, a sharp drop in weekly jobless claims, U.S. regulatory clearance of a new one-dose vaccine, and passage through the U.S. House of Reps of Biden’s totally unnecessary massive new stimulus bill. As I’ve said, the U.S. economy appears to be on a tear – strong growth in the economy and corporate earnings is very likely this year, though whether it will deliver the sustained lift in inflation that bond investors are worried about is much less clear.
Where to now? As it stands, long bond yields now appear reasonable near-term value on the basis of sustained sub-2% inflation and and no signals of Fed tightening for at least a year. That said, as explained in last week’s Bites, the big near-term risk at least is a short-run spike in inflation which could lead to a further capitulation among bond investors and pullback in equity markets (where 20+ PE valuations have been predicated by low sustained bond yields). A move in U.S. 10-year bond yields to 2% seems entirely possible on a few high U.S. inflation readings in coming months, which could easily create conditions for a decent 10% correction in equity markets.
In terms of the week ahead, markets will obviously be watching the bond market closely. Data wise, the highlight is Friday’s U.S. February payrolls report, where a ~160k job gain is expected after subdued results over December and January caused by the COVID third wave. Indeed, given the broad-based strength in a range of indicators, I suspect employment may well surprise on the upside, which risks another bond rout. In short, we now seem in a world where good news is bad news!
Global equity trends
The reflation trade did not help emerging market stocks last week, which fell relatively more heavily given the retreat in risk taking and widening in emerging market bond spreads. As noted above, however, value had a good win over growth, with the trend favouring this post-COVID ‘re-opening’ trade strengthening. Australia’s relative performance also remains relatively uninspiring, despite strength in commodity prices and the $A.
The bond market rout was especially aggressive in Australia last week, with 10-year bond yields surging an unbelievable 48bps to 1.92%. Local special factors include the fact that the RBA is effectively pegging 3-year bond yields at 0.1%, meaning those seeking to short-sell bonds can only really do so at the longer end of the curve. The result is a very steep yield curve, kinked at the point the RBA has stuck its finger in the dike. Along with the global trend, high beta tech stocks buckled last week while material and energy stocks actually gained. The global reflation trade helped the $A finally crack US80c, though it subsequently slumped back to US77c.
Economic data remained consistent with good growth but low inflation, with annual growth in the wage price index remaining at a subdued 1.4%, while the capital expenditure (‘CAPEX’) survey revealed a 3% lift in Q4 private investment spending and expectations for moderately good growth in investment of the next year.
This week’s data highlight is Q4 GDP on Wednesday, with good growth of 2.5% expected – driven by consumer spending and the home building boom. We’ll learn more about the likely GDP outcome, however, over the next two days with reports on Q4 exports, company profits and inventories. The RBA also meets on Tuesday, with a focus on what if anything it might say or do in response to last week’s local bond market rout. My expectation is that the RBA will merely affirm current policies, though another attempted ‘big bang’ announcement of a larger and longer QE program can’t be ruled out.
Of course, the risk for the RBA – and global central banks in general – is that they find they can’t control yields as easily as they might have expected in the face of a market that determinedly disagrees with their benign inflation outlook or the likely actual path of central bank policy. After all, central banks long ago gave up believing their market transactions alone could control exchange rates, and their inability to control bond rates (especially of longer duration) could soon be similarly exposed.
Have a great week!