Quantitative Easing

Stock market bravery tested as bonds shed light on the danger of Fed policy

(Bloomberg) – The fastest impression of inflation in nearly 40 years is making nerves tremble on Wall Street, where economically sensitive transactions are tied to an ultra-accommodating Federal Reserve.

The spread between the five-year and 30-year Treasury yields has narrowed steadily this quarter, with that curve now near its flattest level since March 2020. It’s a sign bond traders are betting that faster rate hikes will undermine the searing economic expansion, possibly disrupting the business cycle in the name of the credibility of the fight against inflation.

A multitude of stock market corners under a heady S&P 500 are channeling bond market angst, with dampening stimuli, still clumsy supply chains and a new variant of coronavirus spreading.

Yet it is far from clear. Many say the bond warning is a false head with a lot of juice remaining in stock transactions linked to the robust recovery.

“Short-term rates are expected to rise and there is a risk that by acting too aggressively the Federal Reserve and other central banks could stifle the recovery,” said Brian O’Reilly, chief strategy officer. market at Mediolanum International Funds. “That’s what the bond market is saying. I don’t necessarily agree.

He still recommends a modest tilt towards battered value stocks due to their steep discounts to the rest of the market, even as the bond market’s red flag for economic growth shakes the assumptions underlying reflation trades. popular.

Read more: Inflation is the biggest threat to the Core 60/40 portfolio

Caution has returned to multi-asset markets this quarter as the Fed sends its clearest signal, but it will accelerate monetary tightening. In the wake of the hawkish turn, swaps forecast rate hikes of nearly three-quarters of a point in 2022. That’s more than the majority of Fed officials said in their latest September forecast, though it does. either subject to change when new projections are released on Wednesday.

The Bloomberg Dollar Spot Index is up for a second straight quarter, and emerging market equities have plunged to the lowest relative to their developed peers in 17 years.

US small caps are forecast for the worst quarter relative to large caps since the first three months of 2020. A defensive game that goes to buying profitable stocks and vice versa is also poised for its best quarter since. start of the pandemic.

The turmoil on the yield curve is a familiar feature of post-crisis markets – and it sparks plenty of conflict again this time around. The head of global bonds at Janus Henderson said this week that the flattening was coming to an end. 22V Research says yield curve relief comes after Covid fears subside and cyclicals are still the way to go.

According to their calculations in a note on Thursday, the recent collapse of the two- and ten-year deviation from its 200-day average sits at the 100th percentile historically, meaning it almost never has evolved as quickly.

“The yield curve is too flat,” said Gene Tannuzzo, global head of fixed income at Columbia Threadneedle. “QE and asset purchases have both become very important parts of what central banks do. Because of this, longer term returns are less of a natural signal. ”

With little conviction, the about-face is everywhere. 20-day volatility in long-short value and momentum factors hit their highest level since April of this week, as risk appetite swung like a pendulum based on omicron headlines.

For those defying bond worries, there is plenty of room to bet on another acceleration in reflationary transactions that lost momentum just before the summer after the first phase of economic reopening. The gap between global growth stocks and value stocks – the most expensive and cheapest corners of the market – has widened since the dot-com era 2000, as cheap stocks have undergone. performed despite a sharp rebound in earnings.

However, it is not as easy as cheap or expensive. Within the value complex, while stocks like commodities that benefit from inflation have held up better, others are dragged down by the economic worries signaled by the yield curve, said Andrew Lapthorne, manager. global quantitative strategy at Societe Generale SA. For example, financial stocks – which borrow short to lend long – are the second worst sector in the S&P 500 this quarter.

Among expensive stocks, stable stocks outperformed while volatile stocks like the futuristic ARK Innovation ETF suffered.

At Ned Davis Research, strategists see good reason for the flattening of the yield curve as economic growth is expected to slow. This suggests that large caps should beat their smaller counterparts, and steadily growing stocks will outperform cyclicals in 2022.

At Mediolanum, O’Reilly recognizes that the appetite for big risks in speculative technology can be curbed by the Fed. But he still finds reasons to trust economic data.

“We have to remember how accommodating monetary policy is,” he said. “Eleven million job postings in the United States don’t tell me the Fed is wrong.”

© 2021 Bloomberg LP


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