It was all about US Treasury yields last week, which remained stubbornly high and increased further on better-than-expected US payroll data on Friday. The casualties were tech stocks, both the old guard and the new “high flyers”, whilst the beneficiaries were financials, oil companies, and recovery/reflation stocks generally. Oil reached a pre-pandemic high and gold continued to fall. There’s a lot of uncertainty at the moment as both bond and equity markets remain unsettled, even as news on the pandemic improves and the end is in sight. Fortunately – and hopefully a harbinger of the coming week – equity markets rediscovered their mojo mid-session on Friday and rallied throughout the afternoon, finishing the week with solid gains for the day and clawing back some of the week’s earlier losses.
What happened last week?
UST yields moved higher again this week, with the 10yr UST yield up 12bps to close the week at 1.56%. The yield curve continued to steepen: 2-10yr UST yield spread, which was 0.80% at end of 2020, is now 1.42%. Higher yields spooked equity markets much of the week. Going against the trend in US government bond yields, governments bond yields were modestly lower in the UK, Europe and Japan, although all remain elevated YtD.
UST’s are clearly not the place to be, and IG corporates are in dangerous territory now, too. HY loans (“protected” against increasing rates due to rate basis, secured/top of capital structure) and high yield bonds offer more protection against rising Treasury yields. Both benefit from an improving economy, at least partially offsetting the effect of higher underlying UST yields. This Moody’s Analytics article (here) presents a very good historical overview of how higher yields have effected asset classes like equities and high yield bonds in past periods of rate increases.
US equities were all over the place last week, but themes in favour were energy, banks, recovery stocks and value plays, all stable to better, whilst tech / other high volatility names were punished, attributable to higher yields. You can see this in the table below, as the NASDAQ was the week’s worst performer, whilst the DJIA was the best. Japan and Europe (including the UK) remain more attractive value plays vis-à-vis the US and China, and the MSCI EM index feels reasonably resilient (albeit subject to periods of volatility) as the global economic recovery benefits emerging markets countries.
The London Stock Exchange (LSE) is apparently considering softening some of its provisions to allow the listing of SPAC’s and dual-class voting structures so as to defend challenges from continental European exchanges as the post-BREXIT struggle in the financial sector between the UK and EU continues.
Inflation might be a fear, but you wouldn’t know it from the price of gold which continues to trend lower, closing Friday at just below $1,700/ounce for the first time since April 2020. The USD and Yen – safe haven currencies – were stronger on the week, and VIX spiked again briefly above 31 on Thursday before settling Friday as sentiment improved, closing at 24.66. BTC was volatile as usual, but on Friday at 9pm GMT was $49,031, up 5% W-o-W.
OPEC+ held the line on production at a meeting this week, which pushed oil prices even higher as the post-pandemic economic recovery takes shape. WTI oil closed the week at $66.29/bbl, + 7.5% W-o-W.
In economic news, Fed chairman Powell spoke at the Wall Street Jobs Summit on Thursday (video is here). He acknowledged higher interest rates in the bond market but stuck to his guns as far as employment being the principal focus for the Fed rather than bond market yields. The fact is that equity investors have become addicted to the Fed manipulating rates in favour of equities and wanted a more aggressive response, which they did not get. I think the Fed should stick to its objectives as articulated time and time again, and let the pieces fall where they may as far as bond yields. In fact, by Friday afternoon all had been forgotten as concerns regarding higher yields were relegated and equities rallied.
Payrolls were much stronger than expected on Friday in the US, with 379,000 new jobs created in January and unemployment decreasing slightly to 6.2% – see the U.S. Bureau of Labor Statistics release here. Even though payrolls were better than expected, the Biden Administration used this report to promote the proposed $1.9 trillion stimulus plan as it is debated in the Senate, almost certainly heading towards approval in some form. I think the package is simply too much – you can read my article about the pending stimulus plan here.
Chancellor of the Exchequer Rishi Sunak presented the 2021 UK budget to Parliament on Wednesday, and you can find the main features of his plan in the transcript of the speech he made in Parliament here. The UK government will provide another £65 billion of stimulus to assist various segments of the UK economy as it slowly emerges from the grips of the pandemic, increasing UK debt to the highest level since WWII. Importantly for many, Mr Sunak agreed not to touch marginal tax rates or capital gains taxes through at least 2025, likely to give the UK economy another much-needed boost.
The week ahead
Even though US equity markets finished strongly on Friday, it was a wild week. Buyers and sellers need to find the right balance and establish a new equilibrium with a base case assuming that UST yields will gradually increase. Things break down when yields gap up, so hopefully, these sorts of harsh moves will not occur again.
For the first time this week since the darkest days of the start of the pandemic, I felt that there were more investors selling into price increases than buying the dips. The new tech / high flyer names were annihilated much of the week, as their rather ridiculous valuations caused many to come under intense selling pressure.
I don’t normally follow US Treasury auctions, but the poor auction this past Thursday seemed to be a catalyst for a further leg down in equities. As a result, the Treasury bond auctions this coming week will be closely watched. 3s/10s/30s are being auctioned on Tues/Weds/Thurs next week – schedule is here.
We will likely see the Biden stimulus plan approved towards the end of this coming week or early the following week, perhaps slightly smaller than $1.9 trillion but not enough to matter as the economy will be further energised and inflation fears stoked. Although the trades are getting crowded, the obvious plays are recovery stocks, banks, commodities and the beaten-down energy sector.
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Excellent thoughts Jim, thank you. I guess we've seen this film before, or a version thereof, both in the US and more recently in Europe. This has been an interesting two weeks, and I really hope that the coming weeks are NOT as interesting! We need "steady as she goes" whether up or down, but no more shocks / surprises. I think things will settle down from here, or I certainly hope so.
Easy money should (and always does) come to an end & somebody ends up holding the bag when it does. The hockey stick business plans and jam tomorrows are first in line for a healthy reset. If this was all that ever happened, central bankers would have a much easier existence not having to worry about collateral damage in established economic sectors, unemployment, falling participation in the labor market, widening of wealth gaps and other unpleasant, unintended realities.
QE, as we know it today, is a recent development but been around long enough for certain known risks to be predictable like asset bubbles, excess liquidity modifying credit provision behavior, etc. We have seen a taper tantrum in 2013 when the…