The Daily Prophet: Nowhere to Run, Nowhere to Hide

Connecting the dots in global markets.

It's starting to look worrisome in the stock market. It's not just that technology shares, which have led equities higher all year, are faltering, sending the Nasdaq 100 Index to its lowest level since mid-May. It's what the rotation out of growth and into value stocks suggests: Investors may be questioning the prospects for a stronger economy in coming months, just as central bankers turn up the hawkish rhetoric.

Few are willing to be brave and ride out the turbulence in the same week that Federal Reserve Chair Janet Yellen expressed concern that some asset prices had become “somewhat rich” and the International Monetary Fund cut its outlook for the U.S. economy. It's not just in the U.S. The upward momentum in stocks has stalled globally, with the MSCI All Country World Index poised for its worst month since October, producing little to no gain. Central bankers are coalescing around the message that the cost of money is headed higher -- and markets had better get used to it, according to Bloomberg News' James Hertling, Alessandro Speciale and Piotr Skolimowski.

"When combined with rich valuations for developed market equities, this can only warrant caution in terms of equity allocations," Alastair George, an investment strategist at Edison Investment in London, wrote in a research note. Just a week after signaling near-zero interest rates were appropriate, Bank of England Governor Mark Carney suggested Wednesday that the time is nearing for an increase. Canada’s Stephen Poloz reiterated that he may be considering a rate hike. The European Central Bank's Mario Draghi said this week that deflationary forces have been replaced by reflationary ones.

Hiding out in bonds no option. The sovereign bond market took its third straight hit of the week and are in jeopardy of having their first losing month of the year, based on the Bloomberg Barclays indexes. European bonds have been punished particularly hard, with the yield on the benchmark 10-year German bund rising as high as 0.46 percent Thursday from as low as 0.23 percent Monday. Two weeks of hawkish rhetoric from policy makers around the world has rewritten the outlook for bond markets, according to Bloomberg News' John Ainger, Stephen Spratt and Maciej Onoszko. The Bank of England and Bank of Canada are now seen as more likely than not to join the Fed in raising rates before the year is out, based on overnight index swap rates. Even the possibility of an ECB hike, once seen as all but impossible, is slowly growing. “Bond markets have been conditioned to thinking that whenever there was a slip-up in risk appetite somewhere and a tightening in financial conditions, the central banks would come to their rescue,” said Mark Chandler, the head of fixed-income strategy at RBC Capital Markets. “Now it’s almost as if the central banks are engineering the tightening in financial conditions. Does that mean more volatility? The sure answer would be yes.”

Judging by the dollar's continuing struggles, currency traders remain unconvinced that the Fed will raise rates again this year. The Bloomberg Dollar Spot Index is trading at the lowest level in nine months, having erased the so-called Trump bump and then some, as currencies including the euro, pound and loonie surge on expectations of tightening monetary policy by their central banks, according to Bloomberg News' Katherine Greifeld. That’s helped to push yields on foreign debt higher on a relative basis, making it even tougher on dollar bulls. “All of this means that the dollar gets less support from U.S. interest rates,” said Kit Juckes, a strategist at Societe Generale. “A stronger dollar needs higher yields than it did before, because the rest of the world is moving.” The yield on 10-year German bunds has risen to its highest in eight months relative to their U.S. counterparts amid the shift in expectations for tighter monetary policy in Europe.

Oil prices have plunged back below $50 and the U.S. is threatening new sanctions on Russia. So, it's probably not a good time to go into Russian bonds, right? Well, not exactly, it turns out. The share of Russian government debt owned by foreigners has risen to a record, according to Bloomberg News' Natasha Doff and Artyom Danielyan. Money managers at Aberdeen Asset Management and M&G Ltd are maintaining overweight positions in the country’s ruble government bonds, lured by yields that more than three times those on U.S. Treasuries. Russian policy makers have won a seal of approval from foreign bond investors this year by reining in inflation while reducing interest rates only gradually. Viktor Szabo, a London-based money manager at Aberdeen, said the yield on Russia’s 10-year notes could drop to 7 percent from about 7.67 currently. Russia's ruble has even managed to show a small gain of about 3 percent this year versus the dollar. It's not all good news: the benchmark Micex Index is down 15.8 percent.

Egg supplies in the U.S. have surged so much in recent months that prices are the lowest for this time of year in at least a decade, according to Bloomberg News' Sydney Maki. It will probably take a while for consumers to eat through the surplus inventory, so the government is predicting egg costs will drop more than any other food group in 2017. The slump marks a sharp turnaround in the egg business. In 2015, an avian influenza outbreak forced farmers to destroy millions of birds and prices skyrocketed. Eager to take advantage of the rally, producers expanded flocks that were the biggest ever by the end of last year. But demand hasn’t kept pace. While some farms have scaled back in recent months, hens have gotten more productive, keeping the market flush with supply. "The market was temporarily starved for eggs, and now it’s drowning," said Tom Elam, president of Carmel, Indiana-based consulting firm FarmEcon LLC. "There’s just too many eggs out there.”

The Bank of Canada's Poloz has been sounding pretty hawkish lately, reiterating this week that he’s considering raising interest rates as the economy heats up and spare capacity disappears even with oil prices falling below $50 a barrel. On Friday, the government will release data on April GDP, and if it comes in below estimates of 0.2 percent there are going to be a lot of angry currency traders. That's because they've been bidding up the Canada dollar on the prospects of higher rates. In fact, out of the 31 major currencies tracked by Bloomberg, only the Czech koruna has appreciated more than the 3.34 percent gain in the loonie. Investors are assigning about a 75 percent chance of a rate increase at the Bank of Canada's July 12 meeting.

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The Fed Tries to Change the Bond Market Narrative: Scott Dorf

Central Banks Won't End the Party Too Soon: Komal Sri-Kumar

China's Bonds Are Ready to Join the World Stage: David Millhouse

Investors Have Lost Sight of the Purpose of Indexes: Aaron Brown

Never Mind Central Bank Head Fakes, Watch the Economy: Gadfly

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