If you take anything away from the week that was (other than that the Fed is going to cut rates in July, of course), it should be that equities managed to make new highs despite rising bond yields.
The story of 2019 has been the simultaneous rally in stocks and bonds, and while, taken to extremes, that creates a “disconnect” that some see as untenable (the “jaws“, as it were), it’s not difficult to explain. Stocks rallied on the assumption the Fed has enough ammo and credibility to head off a recession, and bonds reacted to the promise of a return to accommodative policy and the economic weakness and falling inflation expectations which necessitated the dovish pivot in the first place. In addition, easy money and abundant liquidity is the rising tide that lifts all boats, so bonds, equities and credit all rose together for most of this year.
It’s also quite simple from a mechanical perspective. “I don’t see an inconsistency in the recent performance of stocks and bonds because stock values are fundamentally determined by the present value of expected cash flows, so, when the Fed shifted to a much easier stance, it made sense that both interest rates fell–which was good for bonds–and stock prices rose”, Ray Dalio told Goldman in an interview published Thursday evening.
The worry, though, was that because bad news had become “good” news to the extent weak data and trade tensions presaged a return to central bank easing, any overtly positive development (e.g., June’s blockbuster jobs report) or, potentially “worse”, a rogue inflation print that suggested price pressures are building just when the Fed is prepared to use the “subdued inflation” excuse to justify preemptive rate cuts, would throw stocks for a loop.
So, it’s quite encouraging for equity bulls that the S&P managed to make new highs this week despite the upward pressure on yields exerted by the combination of hotter-than-expected reads on CPI and PPI and, notably, a very ugly 30-year auction on Thursday.
“I think it is extremely important that equities are rallying with the 10 year Treasury yield ticking higher”, Peter Tchir, head of macro strategy at Academy Securities, said in a Thursday note.
Stocks have now risen for five of the last six weeks.
In the bottom pane, you can see yields move higher at the end of the week (blue line is inverted) even as stocks pressed to new records.
“This dynamic, if sustained, allows for good economic news to be good news for risk assets”, Bloomberg’s Luke Kawa wrote, in his weekly fixed income newsletter, adding that earnings will need to hold up too if stocks hope to move higher still. As he also notes, “it helps that central banks, namely the Fed, are perceived to be slightly data-independent at this juncture, poised to boost stimulus no matter what”.
Indeed.
The market always looks forward. After the July Fed meeting, what will be the positive the market is looking forward to? Rising earnings? An imminent end to the trade war? Another rate cut? What will make people think, “I need to buy now, before xyz happens”?
In this day and age of the ever changing narrative and the over parsed data.”simple takeaway” is nearly impossible…The options politically for anything other than a ” levitated forever ” market are not plausible for the short term survival or benefit of any participant entity. For that reason all governments act in unison to kick the can down the road… At some point someone gets a death grip or is pressed ever closer into an existential situation and voila a surprise become a higher probability….Chess if you will……….