Feelings
For some reason, people are feeling good. Animal spirits are on the run. For one dramatic illustration, if we use the popular (but wildly over-simplistic) definition that any 20% gain is a “bull market,” the NYSE Fang+ index is back in a bull market. The index includes the big hegemonic internet platform companies and has been creamed since peaking late last year, but it has now made up that much room since hitting bottom in May:
Q2 2022 hedge fund letters, conferences and more
On an intra-day basis, the Nasdaq Composite index has also registered a 20% gain from its low, which came in June. Bear markets regularly include deceptive rallies, but this is a forceful advance.
Meanwhile, as tech stocks have surged, bonds continued to show exceptional volatility. During the course of Wednesday’s trading, the benchmark 10-year Treasury yield rose from 2.7% to 2.84% and dropped all the way back again by the end of the day:
The dramatic rise in yields from Tuesday’s trading remained intact, but this takes a lot of explaining. It’s driven by sentiment more than anything else, but how to explain that sentiment? This summary, offered by George Goncalves, head of US macro strategy at MUFG, to my colleagues Ben Purvis and Mike MacKenzie, is plausible:
“Yields rose to levels that looked attractive and the buyers started with the back end and it feels like cash was being put to work in fixed income. There is no sense of a catalyst, but the fact the market can’t hold higher rates suggests there is some skepticism among investors that the Fed will not really deliver on its tough talk.”
Recession Talk
Where do such sentiments come from? There are many ways to measure this, but straight counts of stories on the Bloomberg terminal (it tallies all the stories available, not just the ones by Bloomberg News) suggests that worries about inflation have begun to recede, just a little:
This chart uses a rolling 20-day sum, because otherwise the spikes on the days that CPI data come out make it difficult to read. But if people are getting a little a less worried about inflation, a Bloomberg story count suggests that fears of recession have just surged to an almost irrational degree. The recent peak owes something to the publication of second quarter gross domestic product data, but the trend is still clear; there are more stories about recession now than there were at the height of the Covid lockdown in March 2020:
Put these together and you have a partial explanation. Falling bond yields are what we would expect if people are more relaxed about inflation and more concerned about a recession. And falling bond yields, in their own right, are good for stock valuations — and particularly, in recent years, for “long duration” companies whose worth is tied up far into the future. Hence, the rebound for the FANGs makes some sense.
Now we come to the problem. The Federal Reserve has made it abundantly clear this week that it doesn’t want anyone to think that it will be relenting on hiking rates any time soon. Behavior in both stock and bond markets is therefore fighting the Fed, which the oldest trading cliche in the book tells traders they must never do.
Tantrums
There’s also a collective action problem. The Fed can raise the rates that it directly controls; but it also needs broader financial conditions to tighten. If the bond market does not oblige, then the chances rise that the Fed has to push harder, risking a financial accident in the process. The contrast with the last time it tried to change market rate expectations this dramatically is instructive. The 2013 “Taper Tantrum,” when the Fed under Ben Bernanke started to try to ease the market off infinite doses of quantitative-easing asset purchases, was startlingly similar to the way the bond market behaved this year. Here is how the 10-year real yield (a measure that truly captures whether financial conditions are tight) moved from the beginning of 2013 and from the beginning of 2022:
At this point in proceedings in 2013, real yields were leveling off. That was in part because the Bernanke Fed didn’t want them to rise too far, and even postponed the start of its tapering from September to December to help the market calm down. This time around, the Fed isn’t so squeamish and wants real yields to keep rising. Unlike in 2013, it’s already hiked rates several times and is actively shrinking its balance sheet. The fact that traders came within a couple of basis points of taking the real yield negative at the end of last week, then, is bizarre. Even during the tantrum, there was no big market rethink and turn of direction like this. So the bond market seems extravagantly confident that it can fight the Fed, and is behaving very differently from the last time the central bank administered such a shock.
Read the full article here by John Authers, Advisor Perspectives.
