Mainstream media outlets leaned on old faithful to explain another dizzying session for US equities, which kicked off what could be a manic week with gains after “dip buyers emerged.”
Who knows if that’s accurate. It depends on what you mean by “dip buyers.” And it scarcely mattered. Accounts of a given session’s price action are stale the moment they’re written, and Monday was marred by an absurd flash crash in Sweden, apparently triggered by a screwup at Citi’s London desk.
David Augustsson, a spokesman for Nasdaq Stockholm, told Bloomberg it wasn’t a technical issue. “The cause of this move… is a very substantial transaction made by a market participant,” he said. “This move” was a fleeting 8% decline on the local benchmark. Because nothing happens in a vacuum anymore (although plenty happens in vacuum tubes), that “erroneous” trade rippled across European markets. I tried a classic American cinema joke on social media: “I did that. I did that. That’s my fault.” “It’s ok, the table broke the fall.” Nobody got it.
More importantly, there was no respite for bonds to start a critical week. 10-year US yields breached 3% for the first time since December of 2018, when stocks were busy crashing amid Donald Trump’s efforts to build a wall on America’s southern border and Jerome Powell’s efforts to keep his job and fend off detractors angry at his persistence in hiking rates and shrinking the balance sheet.
The most notable aspect of Monday’s action in rates was the juxtaposition between breakevens and reals. The former fell 7bps. The latter rose 17bps, the largest single-session increase since the wild days of March 2020 (figure below).
That brought the two-session increase to 30bps, a remarkable tightening impulse, to put it mildly. It’d be more apt to call it a shock. Five-year reals are within 20bps of turning positive.
I spilled quite a bit of digital ink on Sunday and early Monday explaining why this matters. Suffice to say it’ll be topical for the foreseeable future.
Read more:
The dynamics are important. The mechanical impact of falling breakevens on reals has the potential to engender volatility in equities, even as we do need inflation expectations (market-based and otherwise) to recede.
“Contained within the milestone price action was 10-year real rates’ second foray above zero since the pandemic, and unlike the first instance, today’s TIPS selloff reached >15bps,” BMO’s Ben Jeffery and Ian Lyngen wrote, noting that, for now anyway, the Fed is likely pleased with the situation given the decline in market-based measures of longer-term inflation expectations.
“Whether the influence of aggressive rate hikes or SOMA’s more outsized participation in TIPS, higher reals and lower breakevens is precisely the market outcome the Fed is pursuing,” they went on to say, before summarizing the quandary for stocks as follows:
What is left to be seen is if this tightening can persist in a (relatively) orderly fashion. Just as consequential for the overall market as the outright level of rates is the speed with which the move toward higher yields has occurred. A slow, grinding move toward a positive real yield environment that does not unduly tighten financial conditions or drive a faster selloff in domestic equities is the variety of response that would give the Fed cover to proceed aggressively.
That’s the crux of the issue — a concise way of making the same points spelled out over many more words in the pair of linked articles (above).
Again, it’s the rapidity of the move that matters, and on that score, the recent push off record lows and into positive territory has been breakneck (figure below).
Considering the trajectory of the incoming data, it’s very difficult (for me anyway) to explain this by way of anything other than policy expectations. That makes it a “pure” tightening impulse.
When you consider the read-through for the dollar, and the extra tightening exerted by a stronger greenback, it’s a challenging situation for risk assets.
Jeffery and Lyngen were diplomatic, but they underscored the point. “Concerns on stagflation… defined the week just passed and coming in from the weekend it was 10-year yields moving above 3% that set the tone ahead of Wednesday’s FOMC decision,” they said on Monday afternoon, adding that “we’re left to anxiously consider whether the S&P 500 will be the next benchmark to join the land of the 3-handle.”
I would be curious to know the state of liquidity in the US Treasury bond market.