After an early week swoon in risk markets including an especially harsh sell-off in equities on Thursday, risk assets re-discovered their mojo on Friday to end the week on a strong note even though most equity indices were lower for the week. The catalyst for the shift in sentiment on Friday was a shockingly strong US March jobs report released before the market opened, affirming the strong state of the US economy. While the jobs report was positive for US equities, it was another kick-in-the-shins for fixed-income investors. Yields on US Treasury bonds increased 15bps to 20bps across the maturity curve, most acutely at the long end. It now seems rather entrenched in investors’ minds that the Fed will move at most three times this year (and perhaps less), especially since it is increasingly clear that US economic exceptionalism does not appear to be going anywhere anytime soon. Even higher oil prices and growing geopolitical concerns could not completely derail the return of risk-on sentiment on Friday, which remains supported by sold economic data (especially in the US), expectations of upcoming policy rate reductions by the world’s major central banks, and “buy-the-dippers” that rock up even on small declines in equities.
US jobs report
The US added 303,000 jobs in March, well above consensus expectations of 200,000. The US unemployment rate unexpectedly declined to 3.8% (from 3.9% in February). Friday’s release of the March jobs report by the Bureau of Labor Statistics is here. The Biden Administration is continuing to try to capitalise as much as possible on the strong US economy. You can read the statement from Acting Secretary of Labor Julie Su following the strong March jobs report here.
Fed talking heads
Fed chairman Powell spoke at Stanford University on Wednesday, and you can find the transcript of his prepared comments on the Fed website. I heard nothing new as far as expected future policy moves, with Mr Powell reminding investors as usual that the Fed remains data dependent. Mr Powell also did not suggest any changes to the FOMC’s last set of Economic Projections (March FOMC meeting) which is forecasting three reductions in the Federal Funds rate this year. Other Fed officials were slightly more vocal on future Fed policy, with Minneapolis Fed President Kashkari (not on FOMC) garnering the most attention when he said that the Fed might not need to reduce the Federal Funds rate at all this year. You can find his interview on the “Pensions & Investments” website here. Two Fed officials – Dallas Fed President Lorie Logan and Federal Reserve Governor Michelle Bowman – discussed the neutral rate of Fed Funds this past week, with both suggesting that the final stop for the policy rate once it starts to be reduced could be in the 3%-3.5% area rather than the 2%-2.5% area. None of the Fed-speak was lost on bond investors, as the sharp rise in yields illustrates.
I believe that the Fed is doing a good job telegraphing its thought process as far as future shifts in monetary policy. It’s never safe to say too much since investors are often conditioned to hear what they want to hear. Given the current glide path of the economy, I would tilt towards only two reductions in the Fed Funds rate this year, and it seems that investors are slowly moving towards this realisation too. It is the Federal Reserve’s job to assimilate all available data in developing its monetary policy, which must remain dynamic to reflect their twin policy goals of 2% inflation and full employment. The fly-in-the-ointment is that lags in monetary policy can be unpredictable. It is the Fed’s objective once inflation is safely contained to start to lower rates before economic conditions sour too much, but how the timing of a tilt towards dovish monetary policy ultimately filters into the real economy is far from a perfect science. Having said this, I see little reason given the robustness of the U.S. economy that the Fed should do anything at all for now.
Bonds hammered
Although equity markets clawed back some losses on Friday, yields in the bond market pushed higher after the March jobs report, adding to the steady march upward in yields that has largely been occurring since the beginning of the year. With yields 15bps to 20bps higher across the curve on the week – and now 50bps higher since the beginning of the year – bond investors are once again getting hammered. The long duration ICE BofA 20yr UST total return index is down 6.7% YtD, as higher UST yields continue to wreak havoc in fixed income markets. Investment grade corporate bonds have been unable to escape the malaise in underlying Treasury yields (BBB corp bonds -0.5% YtD), although high yield bonds have experienced enough (credit) spread compression to offset the sharp increase in underlying UST yields. High yield bond total returns have been around 1% YtD.
Gold and oil
Watching gold prices soar this year even with risk-on has been unexpected, reflecting fears of inflation remaining elevated for longer than expected (or hoped), and / or heightened geopolitical risk. There might be technical dynamics at play, too, with some central banks swapping out USTs (Dollars) for gold in order to reduce their vulnerability to the US weaponing the Dollar. Whatever the drivers, the fact is that gold is up nearly 13% YtD. Oil has also been steadily moving higher, perhaps for similar reasons as gold. However, higher oil prices will eventually act as fiscal brakes on the global economy, a sort of fiscal restraint that is self-correcting. The effect on equities has been nice moves higher for gold mining stocks and oil company stocks YtD. The gold mining ETF GDX (VanEck) is up 9.1% YtD, and the oil companies benchmark EFT XLE (State Street) is up 17.9% YtD.
What could stop the fun (for risk investors)?
Earlier this week, I sent an email to my subscribers discussing what could go wrong in risk markets. Most likely, it is something we see but are not properly pricing, or some sort of black swan event that is not even on the horizon at the moment. I suppose the two things that most concern me, which we can see now on the horizon, are the upcoming U.S. Presidential election and all the fireworks that will entail, and risks around the broadening of one or both global conflicts (Ukraine-Russia and Gaza-Israel).
VIX vs MOVE (the volatility indices)
The VIX index is a measure of stock market volatility in the US, and the MOVE index is a measure of bond market volatility. The fact that volatility in bonds is higher than volatility in equities seems counter-intuitive, but that is exactly what we have at the moment as you can see in the graph below from #SIFMA and #Bloomberg.
The good news I suppose is that volatility has been falling in both the stock and bond markets. Strangely though, as the graph illustrates, bond market volatility has mostly been above stock market volatility since 4Q2022. This means that US Treasuries and most investment grade corporate bonds have not only had poor (negative) returns, but are also riskier than stocks, reflecting uncertainties as investors try to predict monetary policy in the context of sticky inflation and strong economic data.
MY TRADES LAST WEEK
I like Lululemon (LULU) and own a chunk, but the stock is continuing to get mercilessly hammered through a combination of a recent run-up that was too much / too fast, and management pulling back on forward guidance with respect to sales in the coming quarters. The stock is down 30% YtD so I decided to add to my position late in the week since the price of the shares based on rudimentary valuation metrics is not stupid (albeit elevated). (As an aside, I had a long (covered) call ($500 strike) / put ($430 strike) straddle on the shares that unfortunately expired in late January, proving my timing is generally rubbish!) I also added to JNJ last week as a defensive tilt, even though the stock performance has been rather uninspiring. Lastly, I wrote calls / bought puts (flat trade) on GOOG after its recent run-up. I still like GOOG and think it is not overpriced – I’m just not sure I see a lot of upside in the near-term given its sharp bounce off its lows since early March.
THE TABLES
The tables below provide detail across various global and US equity indices, the US Treasury market, corporate bonds and various other asset classes.
Global equities
US equities
US Treasuries
Corporate bonds (credit)
Safe haven and other assets
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