Market Analysis Today – Equities rally looks set to continue
Equities looked poised to continue their rally after the extended weekend with improving infection/vaccination trends lifting sentiment.
But early weakness on the back of soaring US yields is still proving to be a challenge for investors to stabilize footings at current lofty levels.
The general tilt to the tape was a risk on with Energy and Financials securing impressive gains.
Oil is holding near 13 months high after winter weather disrupted power systems across Texas and hindered production.
Right now, the market remains in that sweet zone where recovery prospects are good enough to buy risk, but still too weak for policymakers to remove stimulus.
But the rates curve is starting to tell a very different tale of the tape as policy normalisation is right in markets’ main focus on the sequencing events only getting held up by the fact US Fed Chair Jerome Powell has done too well a job of lulling the market into a sense of complacency, ironically at the same time, the FOMC joint efforts are planting the seeds for a taper tantrum scenario.
Forex markets
The Euro continues to take a US high yield beating as the Eurodollar strip continues to reprice the Fed as the sell-off in US Treasuries continued, dragging the greenback to new highs of the day. There is a sharp sell-off in EURUSD, accordingly.
Expect the US dollar move to continue as rates curve seems to have further room to run.
Rates still rising
It’s difficult to tell if we have reached any significant inflexion points, but it’s certainly starting to feel that the rip higher in US bond yields at least on the margins could be the match in the stimulus powder barrel.
US rates may continue to show the way but perhaps not in the most favourable way for stock market investors.
The US 10-year yield is just above 1.30%, up 20bp in the past week. It was 2.0% in January 2020 ahead of the Covid-19 pandemic.
The 10-year breakeven is up 4bp only in the past week – the other 16bp of nominal yield gain is all real rate and pure money cost.
In turn, the real rate gain is mostly a function of Fed Funds’ higher forecasts than a term premium, and that is a rate checker fact that stock markets generally don’t like.
The December 2025 Eurodollar future has added 20bp in the past week. Indeed, it’s the behaviour of short-end rates rather than the 10-year yield that should be of most interest here for cross-asset and currency traders.
Comparing the strip now to two weeks ago, take off is still expected at the end of 2023 – in line with Fed guidance.
But the pace of hikes is much quicker – the market now prices 1% some nine months earlier than it did only two ago. It’s also pricing the Fed to get rates back to 2.50% (the Fed’s estimate of long term neutral).
Two weeks ago, the market didn’t think the Fed would get any further than 2%. Three months ago, the market didn’t think the Fed would get any further than 1.50%.
What happens if the strip starts to price in a 3% increase in FED Funds, I think we know how that story is going to end.
Market Analysis Today – Equities rally looks set to continue
