Treading Cautiously

Sentiment felt a bit damp again Tuesday, as US equities and rates confronted a data vacuum, leaving earnings, geopolitics and, of course, the virus, to set the tone.

The dollar was on track for its longest losing streak since last summer, as the recent drop in Treasury yields, higher commodity prices and a slight reassessment of the growth divergence thesis (among other things) weighed.

“I hope the Biden/Powell/Yellen era improves US infrastructure, boosts labor market participation and reduces inequality (who wouldn’t hope for that?) but it’s hard to believe it will be a great era for the dollar,” SocGen’s Kit Juckes wrote. “This is emphatically not Reagan/Volcker, but a regime that will anchor real rates and grow deficits.”

Of course, this is always a two-sided debate. You could just as easily argue that a booming US economy and a buoyant US stock market will be a magnet for inflows to USD assets, especially if FX-hedged Treasury yields offer enough pickup to attract overseas demand. Plus, US corporate bonds are still relatively attractive depending on what you’re comparing them to, especially when you toss in what we now know is an implicit government guarantee, at least on IG in a crisis.

The figure (above) shows the dollar on the back foot after what some called a “counterintuitive” bounce. Everything is described as “counterintuitive” these days. A word of pseudo-advice: If everything seems counterintuitive to you, it’s possible you had the narrative wrong.

In any case, BMO’s Ian Lyngen and Ben Jeffery spoke to the real yields story. “With 10-year breakevens holding at 235bps despite the decline in nominal yields, it is clear that the bullish repricing [in rates] has been a function of a longer road to recovery,” they said. “The question now becomes if the reinstatement of the J&J vaccine is sufficient to drive a reversal of 10-year real yields back to the recent peak of -55bps,” they added, noting that their “intuition is that it is highly unlikely, if for no other reason than the willingness of the CDC to pause the usage of the vaccine – while undoubtedly prudent – introduces at least a degree of uncertainty as to the probability of making it all the way to herd immunity without another obstacle in the long drive.”

And maybe that captures it. If you’re looking to explain what felt on Monday and early Tuesday like faltering confidence with equities near record highs, it may just be that with positioning stretched, the J&J situation offered an (extremely) unwelcome reminder that things can go wrong when you’re attempting a historic feat both from a biological and logistical perspective. Indeed, it’s a miracle nothing worse has happened on the way to getting a quarter of the US population fully vaccinated in just 200 days.

Meanwhile, the retail mania looks to have come and gone (Dogecoin and “4/20 Day” notwithstanding).

“It’s not a surprise that Q1 represented the peak. It played out as if scripted,” JonesTrading’s Mike O’Rourke remarked, adding that,

Activity peaked in February in the deep of winter as vaccinations rolled out and economic reopening was in the early stages. Add in multiple stimulus checks and excitement about $2 trillion infrastructure stimulus, and now as spring unfolds, Americans are starting to move on with their lives. School breaks are leading to real vacations, and with each passing day, more activities come back online.

As I put it over the weekend, some of the dynamics behind piqued (and peak) public interest are set to ebb.

Equities could keep rallying, sure, but the the frenzied mood fostered in part by headlines touting Tesla, GameStop, SPACs and other manifestations of froth, may give way to something slightly more rational, as irrational market participants return to day jobs or make their way to beaches and bars.

That’s precisely what O’Rourke was communicating in his latest.

“The SPAC space and ‘story stocks’ in general experienced their own epic speculative bubble [which] has popped and in the case of SPACs, greater scrutiny is on the horizon,” he went on to write, before noting that “while the major indices register new highs, there is pain being felt out there [and] Investors are starting to tread cautiously.”