Anyone who closely follows the composite of investor and analyst estimates regarding the course of the reference rates of the US central bank since the spring of 2022 when their upward trajectory began, it is impossible not to have spotted something rather striking: they have never fallen within their forecasts. When we refer to forecasts, we mainly mean the related derivative product that is traded on the Chicago Stock Exchange and shows us roughly what investors expect from benchmark interest rates for the next eighteen months.
The most common mistake was initially investors’ rush to predict the end of the rate hike process and their even greater rush to start the reversal. For several months now, and since Governor Powell has made it clear that no more hikes are on the horizon, investors’ fortune-telling skills have been strained in trying to predict the start of the rate-cutting process and its evolution.
If we go back a few months we will remember that at the beginning of the year the Chicago Stock Exchange tool showed that investors were almost certain that by 2024 we would see five rate cuts of 0.25%, with the first taking place in March .
The very good course of the American stock markets from last October onwards and the continuous records of the major American stock indices were largely attributed to this assessment. Indirectly, the respective records in Europe and Japan were partly credited to this estimate. A more immediate result of these assessments was the very significant drop in yields of government bonds of the USA.
The one most closely watched by stock marketers, the 10-year US Treasury bond, has seen its yields drop dramatically. While last October they were close to 5%, by early 2024 they had fallen by almost one percentage point and were poised to drop below 3.80%. Similarly, a significant drop in yields had been observed in other US government debt securities, as investors considered the imminent start of the benchmark interest rate reduction process to be certain.
But once again, the certainty that Governor Powell and the Fed would rush to lower interest rates proved unfounded. As the governor had warned anyway, the start of that process would be a function of the path of inflation, and Powell and his colleagues’ estimate was for at most three rate cuts through 2024. The resilience shown by the inflation in the US in its last three monthly readings has once again turned things upside down in the markets.
Yields on US 10-year Treasuries rose again and these days are near 4.60%, approaching last October’s levels which were also the highest in the last fifteen years. Getting those yields back to high levels is something that could prove to be very important for the US stock market, and not just for it.
The problem with rising yields isn’t just rising borrowing costs for businesses. It is also the increase in “competition” that stocks face, as the return on the safest investment is elevated.
As the title of a report by its analysts states Goldman Sachs as of this past Monday, “investment risk appetite is being tempered by the return of bond yields to near their highest levels since 2008.” In addition to this, the rise of the US dollar, which is steadily strengthening as the strength of the US economy and the persistence of inflation is more evident than in European economies, is also an inhibiting factor for stock markets.
Thus, US bond yields rise more than European bond yields, pushing the dollar higher. As we saw very vividly in 2022, the outperformance of the US dollar generally does not do the markets much good. Under these circumstances, we are not surprised by the difficulty faced by the international stock markets in recent days.
It is not only concern about developments in the Middle East that worries investors. The picture of rising bond yields may bother them more, at least in the US. As we read in Bloomberg, already the significant rise in yields has begun to attract buyers for US government bonds.
A “poll” conducted by JPMorgan of its clients revealed that they have the most long positions in US bonds for almost a month. At the same time, in the derivatives markets, it seems that a gradual reduction of “bets” predicting a further significant rise in bond yields is underway. The findings reported by Bloomberg confirm that the competition towards the shares has intensified and that investment funds have started to move there.
On the one hand, this is probably negative for demand for stocks, but on the other hand, it may indicate that many investors believe that the continuous rise in bond yields that began in January may be coming to an end, which will be pleasant for the stock markets.
Well-known Bloomberg columnist John Authers tackled the issue of rising bond yields and what that could mean for stocks. Authers first refers to inflation’s refusal to continue the deceleration that began in September 2023 and points out that part of its persistence is due to the fact that the global economy is stronger than many economists and investors expected ( here it is good to recall another completely failed, so far at least, belief of many analysts, namely their certainty that the American economy had no chance of avoiding recession).
The well-known columnist then points out that in the past investors were used to seeing bond yields consistently outperform stock dividend yields, which they gradually stopped seeing after 2008 when we entered the period of very low interest rates. Since the markets very often have what we call “short memory”, Authers believes that the generation of investors who grew up seeing very low bond yields is very likely to have a hard time adjusting to the new data (which is not so new).
Of course, this still does not seem to be the case, but it may happen if the rise in bond yields continues in the coming weeks and especially if the new issues of US bonds, in the amount of 183 billion dollars, expected for the current week are absorbed with difficulty by the investors.
The relevant discussion is not easy to reach a specific conclusion, just like many other discussions of an investment nature. However, this does not negate the fact that the delay in the reduction of reference interest rates has started to trouble the stock markets which see some other investments becoming more attractive.
It’s hard to say how the situation will play out, especially now that investor anxiety over the chaotic situation in the Middle East, which is responsible for much of the rise in oil prices and most of gold’s rise to new record highs, is evident. .
It is certain that the landscape for stocks has become less investor friendly. This does not mean that we will necessarily see a significant drop in the markets, but that much more attention is now required in monitoring their course. Especially now that the announcements of the financial results of the large international companies listed on the international stock exchanges have begun.
If there’s anything that could calm things down and make investors less anxious, it’s good corporate results and positive estimates for the immediate future. We will soon find out whether corporate performance will be able to give the markets a “helping hand” or whether they will be left alone to deal with the various threats that have emerged.
