Good Monday AM,
The volatile continues both in equities and bonds. The close on Friday in the bond market was encouraging. Today things have settled down and we are slipping a bit. At the moment, the market is seeing reasons to believe the job market and inflation will rise, thus driving up the long end of the yield curve. The Fed can control short term rates, but the only way they control long term rates is by buying more bonds. They did this Friday but have stepped back at least for the moment this a.m. Hopefully we found a bottom last week but it is not yet confirmed. If you have been floating, I would consider locking this a.m.
Speaking of rates, Germany’s biggest lenders, Deutsche Bank and Commerzbank, have told new customers since last year to pay a 0.5% annual rate to keep large sums of money with them. The banks say they can no longer absorb the negative interest rates the European Central Bank charges them. The more customer deposits banks have, the more they have to park with the central bank. That is creating an unusual incentive, where banks that usually want deposits as an inexpensive form of financing, are essentially telling customers to go away. Banks are even providing new online tools to help customers take their deposits elsewhere.
The folks at Bloomberg shared a great piece on bonds this a.m..
Selloffs in the Treasury market are inherently more mysterious than stock market declines. Everyone gets their biases confirmed. Maybe it’s good news, because investors are pricing in faster growth. Maybe it’s bad news because the Fed is losing control of the yield curve. Maybe investors are starting to fret about inflation. Maybe it’s the bond vigilantes rousing from their slumber, sending a message about big-time Washington D.C. spending plans. Choose-Your-Own-Bond-Market-Narrative.
Last week, of course, we had this big selloff in the belly of the curve, with yields on five-year U.S. Treasuries soaring, before falling back a little bit.
Anyway, as we start the new week, here’s four quick things to think about in terms of what it all means.
- As my colleague Tracy Alloway wrote about in her newsletter (sign up here), much of the move should be understood as technical. Speculative positioning combined with trend-following strategies basically meant a bunch of different players all got sell signals at the same time, causing an extremely sloppy rush for the exits. Rather than reading too much into the move as some major economic signal, it should be at least in part understood as one of those things that happens in markets from time to time. Some of it is noise.
Of course there is a real policy tension that exists in the market. Friday on TV we talked to Jon Turek, who is the author of the excellent Cheap Convexity newsletter. As he laid it out, the basic issue is that growth in 2020 is expected to be blazing hot, with GDP perhaps even growing in the double digits. Normally you’d think the Fed would be in a tightening bias in such an environment.On the other hand, the Fed has made clear that it’s not so much interested in the path, but rather the destination. It wants to get back to full employment and yet right now we’re nowhere close to the Fed’s goals. As Lael Brainard discussed last week, by one measure the unemployment rate is probably close to 10%. That’s not a level where the Fed is even thinking about thinking about hiking rates.
- Despite all the talk of inflation, it’s really not clear that the market is showing any actual concern. If you look at breakevens, the market is pricing in higher inflation over the next two years than it is over the next 10 years. In other words, there may be some broad-based rise in prices in the short term due to reopening and stimulus, but then nothing that would really be sustained or worrisome over the long term.
- And finally, what we’re seeing happening in the rates market has a corollary to what’s going on in stocks. There’s a reason why Exxon is already up 32% just this year, while Tesla is down 4%. From Goldman Sachs’ latest Weekly Kickstart note:
Of course, shifting interest rates have major implications for rotations within the equity market, a dynamic made clear in recent weeks. In mid-2020, our equity valuation model showed that equity duration – the expectations of earnings growth far in the future – had become a more important contributor to multiples than ever before. One key reason for the importance that investors ascribed to expected future growth was the extremely low level of interest rates. As rates have risen, the contribution of equity duration to stock valuations has declined while near-term growth profiles have become more important. Practically, this means that both the improving growth outlook and rising rates have supported the outperformance of cyclicals and value stocks relative to stocks with the highest long-term growth.
Please remain safe and healthy, make today great!