“The S&P is almost 20% off the December lows [and] if the consensus expectations for US growth have deteriorated, the SPX so far this year has been relatively immune”, BNP writes, in a Thursday note.
That’s generally true, but if this week has taught us anything, it’s that stocks are near the breaking point when it comes to ignoring the message from plunging DM bond yields.
Recall how this developed in the wake of the March Fed meeting (from a Sunday post):
Friday’s action doesn’t bode particularly well – it was a bit of a “perfect storm”, so to speak.
JGB yields had to play catch up (or, actually, “catch down” is better) to the dovish Fed after a holiday and the Japan CPI miss threw gas on the fire. Then came the grievous German manufacturing data and it didn’t help that France’s composite PMI sank back into contraction territory. Ultimately, the die was cast by the time the US session got going.
The data from overseas underscored growth concerns and, more importantly, appeared to lend credence to the idea that the Fed’s dovish surprise might have been predicated on the FOMC “knowing something” everyone else doesn’t know.
BNP recaps all of that in the note mentioned above. “March’s dovish FOMC meeting, with downward revision to dots and balance sheet announcement, and weaker European data triggered sharp moves in rates”, the bank writes, before flagging the various “accelerants” (if you will) documented extensively in these pages over the past several days. “The sharp rally in US rates last Friday triggered further convexity-related buying needs and unwinds in some (consensus) positions (swap spread wideners, long TIPS breakevens and curve steepeners)”, the bank notes.
The rhetoric from policy makers has only served to underscore growth concerns with the RBNZ’s dovish pivot and more cautious comments from Draghi (see here) “validating” the notion that the balance of risks is skewed to the downside, underpinning the bond rally further. The result is this:
If stocks were pricing in the end of the world in December, now bonds have taken the baton when it comes to presaging the economic apocalypse.
Here’s an amusing passage from Barclays that touches on this dynamic:
Ancient cultures looked wonderingly at the sun and moon, at the wind and tides, and ascribed god-like properties to explain away natural phenomena. Modern investors sometimes adopt this approach in periods of financial stress as they parse the message from an all-knowing “market.” In the throes of last December’s equity downturn, we were repeatedly asked what the “market” was saying about the economy. Three months later, equities have roared back. But the US 3m10y yield curve inverted last week, while 10y bunds traded through 0bp. Sure enough, the questions have come back. What, the query goes, is the “market” telling us about the economy? The difference, of course, being that the all-knowing property of stocks has now moved to bonds.
While bonds are notoriously “smarter” than stocks, Barclays thinks it’s unlikely that either asset is “all-knowing.” “The reality, we feel, is more prosaic”, the bank goes on to write, in the same cited note, before delivering a relatively upbeat assessment on things as follows:
Yes, the world economy has slowed quite a bit in recent quarters. Europe, in particular, has disappointed repeatedly, and China has been weak, by its standards. But labor markets in every major economy are in rude health, and central banks are back in the reflation business, helped by the Fed’s about-turn. The global expansion should continue for the foreseeable future, and we do not see any major economy growing below trend in 2019. If equity markets were too pessimistic about the economy late last December, bond markets have taken up that mantle now after a long rate rally.
Yes, bond markets sure have “taken up that mantle” when it comes to being “too pessimistic”, and the rally has rippled across fixed income.
As Bloomberg noted on Wednesday, bond markets have “gone mad” with “everything rallying at once.” “The market value of the world’s investment-grade and high-yield bonds has jumped by almost $1.6 trillion to $55 trillion in the past three weeks”, Sid Verma observes.
Meanwhile, the global stock of negative-yielding debt has topped $10 trillion again, after falling to less than $6 trillion (less than half of its all-time high) last October.
Speaking of negative-yielding debt and odd-ball distortions tied to bond mania, BofAML remarked on Thursday that “globally, the share of the investment-grade debt market with sub-zero yields is close to one-fifth — the highest ratio since September 2017.”
Do note that there are myriad oddities and potentially inconsistent narratives baked into the current state of affairs. If DM government bond yields are “right” about global growth and the US curve really is “telling” us something about where the US economy is headed over the next 18 or so months, then it’s not entirely clear that chasing out the risk curve and piling into carry trades is a great idea.
However, if the bond rally is just a consequence of the coordinated dovish pivot from central banks, and that pivot proves some semblance of successful both at “reflating” the global economy and keeping cross-asset volatility suppressed (never mind this week’s flareup in rates vol.), well then we could conceivably find ourselves back in the kind of benevolent market that made for such smooth sailing in 2017.
Whatever the case, one thing seems clear: Equities appear to be teetering on the verge of getting the “wrong” idea when it comes to what bonds are “saying” about the global economy.