Bond Market Flexes Muscles Over Stock Market

Stocks Suffer as Treasury Yields Rise 

Treasury yields up + market expectations for the path of Fed interest rate hikes up = bad news for stocks. Stocks in Europe and Asia slipped Wednesday after US markets registered their worst day in two months, with the S&P 500 down 2% to below 4,000, as investors reassessed how high rates will go and how long they will stay there. The Nasdaq 100 slipped 2.4% and is testing the 12k level again, its weakest since the Fed statement on Feb 1st when Powell seemed to be declaring victory just a tad early. Earnings are also proving mixed this season – the latest disappointment coming from Home Depot, which fell 7%, taking it to the bottom of the Dow Jones, after it missed on revenue expectations for the first time since 2019. But by and large this is about markets waking up to the reality of how serious the Fed is taking inflation and how much cover the labour market is giving it still.  

The 10yr Treasury yield rose above 3.96% and the 2yr has breached 4.725% as markets ramp up bets the Fed will go higher and longer than they had thought. This is almost a word for word copy of the script from last year when we had the whole pivot story and like that it’s unwinding. Minutes from the last FOMC meeting are due later in the session and will be closely scrutinised for clues about how policymakers are likely to take monetary policy in the wake of data showing a more resilient labour market and stickier inflation than many had expected. The bond market has been sleeping a bit but is flexing its muscles against the puny little stock market again. 

UK Stronger as Europe Falters? 

European stock markets fell broadly in response to the sharp retreat on Wall Street, with the FTSE 100 down another 0.5% or so after giving up the 8k handle yesterday. Shares in Frankfurt declined again too with some hot German inflation data coming in to underline what we are dealing with. German CPI rose 1% on the month in January after declining 0.8% in the prior month – year-on-year hit the forecast 8.7%. We note Deutsche Bank has lifted its forecasts for the ECB Terminal Rate to 3.75% From 3.25%...joining the ‘higher for longer camp’...as more finally get this the contrarian play is the big deflationary depression incoming – either way it’s hard to see a great setup for stocks. Remember the words of Stan Druckenmiller: all those factors that cause a bull market are not only stopping but are reversing.  

Lloyds results look good – a good barometer of the UK economy perhaps – though shares fell slightly. Q4 profits before tax rose 80% to £1.8bn, boosted in large part by the Bank of England raising rates to a 15-year high and continued resilience in the UK economy. Net interest margin in the fourth quarter improved by 65bps to 3.22% in the fourth quarter. Announced share buyback of £2bn. 

BoJ Still in Fight or Flight 

The Bank of Japan stepped into the market after the yield on the benchmark 10yr Japanese government bond breached its 0.5% ceiling for a second day. The move highlights the pressure the central bank is under right now to defend the yield policy and somehow explain how it plans to slowly normalise without causing some sort of market dislocation. session prompting central bank intervention, The BoJ bought ¥300bn ($2.2bn) of JGBs with maturities five to 10 years.  I have talked about the risks associated with the BoJ attempting to normalise policy and whether the market decides to break YCC for it. 

RBNZ Also Fighting Inflation 

The Reserve Bank of New Zealand hiked rates by 50bps as expected, noting that "higher interest rates are needed to ensure that inflationary pressures ease and employment returns to its maximum sustainable level.” In response to deadly storms, the RBNZ said: "The best contribution monetary policy can make right now is to free up resources elsewhere in the economy by slowing demand through higher interest rates". The OCR is now at 4.75%, its highest since 2008, with the RBNZ not going as big as it might have indicated it would last year as it reacted to a slight decline in inflation expectations. Nevertheless, the RBNZ noted that inflation remains “widespread and too high, at an annual rate of 7.2%. Measures of core inflation, which strip out prices that are volatile like fuel and food, have also remained elevated.” It believes headline inflation will stay high in the near term will only begin to decline significantly only from the second half of 2023.  

For the year, the bank reported statutory profit before tax of £6.9 billion, flat with last year, with higher net income and lower total costs offset by impairment charges as a result of the revised economic outlook. Net income +14% to £18bn, boosted by continued recovery in customer activity and BoE rate hikes. Rising rates are having a positive effect on Lloyds’ bottom line, with underlying net interest income up 18%, primarily driven by a stronger banking net interest margin of 2.94% for the year. Provisions for soured loans is up but that is maybe because it’s lending more. Other income was up 4% to £5.2bn. Operating costs rose 6% to £8.8 billion, which management say reflects stable business-as-usual costs despite inflationary pressures, alongside higher planned strategic investment and new business costs. Before impairment charges, underlying profit +46 per cent to £9bn. Lloyds numbers are fine but the question is where next – a lot depends on how well UK households do in the face of the cost of living crisis and higher mortgage costs – how many defaults? And how far does the BoE go with rates? 

Finally: Crypto and Indices Looking Stronger 

Coinbase...crypto bellwether? The crypto exchange reported $629 million in revenue, ahead of the $590 million expected by analysts. But users are declining as the effects of the crypto winter are felt – the number of monthly transacting users (MTUs) fell to 8.3mn during the fourth quarter, down from 8.5mn in the prior period. Bitcoin trades lower for a second day, now below $24k.  

Elsewhere, in SPX MACD crossovers still proving their worth – price action now at the lower edge of the Bollinger channel and major congestion of 50/100/200-day lines close...could be heading for the big one. Near term support found around 3,800, if this goes then I’d think it could be lit.