The Daily Prophet: So Much for the Bond Bear Market Tanking Stocks

Connecting the dots in global markets.

There's a saying that markets will do whatever causes the greatest pain. So, if you like most everyone else bought into the popular theory that faster inflation and higher interest rates would kill the bull market in stocks, then you're feeling a lot of pain. Despite an inflation report Wednesday that sent Treasury yields soaring to their highest since the start of 2014, the S&P 500 Index jumped 1.34 percent.

The gains added to a four-day rally that has sent the S&P 500 up almost 4.56 percent. Globally, the MSCI All-Country World Index of equities jumped the most since April on Wednesday. The memory of last week's rout that sent stocks tumbling into their first correction in two years is quickly fading. Even though the U.S. government said its consumer price index rose 0.5 percent in January, the most since 2013, stock traders felt "comforted" by a separate report that showed weak retail sales. That could mean that the Federal Reserve may not need to accelerate the pace of rate increases to about four this year versus its current projection for three.


“The markets are having attention-deficit disorder, they can’t figure out what they want,” Walter Todd, the chief investment officer of Greenwood Capital Associates, told Bloomberg News. “There is a lot of emotional reaction going on.” To be sure, rising interest rates generally reflect a strong economy, a positive for equities. The strategists at Societe Generale wrote in a research note Monday that of the 17 percent average annualized return in the S&P 500 during periods of rising yields, about 7 to 8 percentage points could be attributed to the increase in yields themselves, according to Bloomberg News' Cormac Mullen.

'PERFECT STORM' HITS BONDS
Bond traders looked past the weak retail sales report and focused squarely on the jump in the consumer price index. The yield on the benchmark 10-year Treasury rose as high as 2.91 percent, continuing its steady advance from last year's low of 2.01 percent in early September. Based on the moves in eurodollar futures, traders expect the Fed to boost rates four times, compared with 3.6 times before the inflation report, according to Bloomberg News' Brian Chappatta and Edward Bolingbroke. "January was either a perfect storm of price increases relative to December or possibly the harbinger of faster inflation that has been a concern since the tax cuts were passed," Jim Vogel, an interest-rate strategist at FTN Financial, wrote in a research note. He said the former is more likely. That might help explain why the yield curve, or difference between shorter- and longer-term rates narrowed. Normally, the curve would widen if bond traders were worried about faster inflation becoming entrenched. Instead, it narrowed, with the gap between five- and 30-year Treasury yields shrinking to 53 basis points from 57 basis points on Tuesday.


CAN'T ANYTHING SAVE THE DOLLAR?
Once again, dollar bulls were left scratching their heads. Despite inflation data that would seem to support the greenback by signaling higher interest rates are coming, the Bloomberg Dollar Spot Index fell the most in three weeks. But then again, maybe that's not such a surprise given that has been the pattern since the start of last year, a period that saw the index drop 11.6 percent despite three rate increases from the Fed. It's becoming clear that few are willing to bet on dollar strength after comments by members of the Trump administration that the currency is too strong. Most recently, Treasury Secretary Steven Mnuchin said last month that a weaker dollar would help exports. While Trump later said Mnuchin's comments were taken out of context, a year earlier he told the Wall Street Journal that the greenback was too strong and "it's killing us." There's also concern about the U.S.'s deteriorating fiscal position. The nonpartisan Committee for a Responsible Federal Budget said it expects the budget deficit to swell to $1.2 trillion in fiscal 2019 alone after the Trump administration enacted tax cuts late last year that will reduce federal revenue by $1.5 trillion over a decade.


THE SCREENS ARE GREEN IN COMMODITIES
It was hard to find any major raw material in the red Wednesday, as energy and metals led the Bloomberg Commodity Index to its biggest one-day surge in three weeks. Crude rebounded in New York after an Energy Information Administration report showed American oil inventories increased by 1.84 million barrels last week. That was lower than all but two of the 11 estimates from analysts and economists in a Bloomberg survey, according to Bloomberg News' Jessica Summers. Gold soared the most since March amid the news that the hedge fund manager Ray Dalio boosted his holdings in the two largest gold-backed ETFs last quarter before prices of the metal capped the biggest annual gain in seven years. Soybean futures rose to a two-month high amid forecasts for drier weather in Argentina, a major producer. The Bloomberg Commody Index is staging a rebound, posting its biggest three-day gain since early September after a slump that caused it to drop 5.7 percent between Jan. 26 and Feb. 9. If inflation is on the rise, commodities are one of the few assets classes that provide a natural hedge. The strategists at Goldman Sachs recently said they are the most bullish on raw materials since the end of the supercycle in 2008. Back then, the Bloomberg Commodity Index climbed 18.7 percent in 2009 and 16.7 percent in 2010.


SOUTH AFRICA TURMOIL ATTRACTS 
Currency traders were really excited about the imminent ouster of South Africa President Jacob Zuma, who resigned just before 11 p.m. local time. The rand posted its biggest increase since December, rising to its strongest level since the first half 2015. The rally on Wednesday extended the currency's gain to almost 24 percent since mid-November. The African National Congress intended to pass a vote of no confidence in Zuma in parliament on Thursday if he had ignored an order to quit from the party’s National Executive Committee, according to Bloomberg News. The ANC wants a quick transition to Cyril Ramaphosa, one of the richest black South Africans, so that he can move to fulfill pledges to revive the struggling economy, clamp down on corruption and rebuild party's image ahead of elections scheduled for mid-2019. The rand and Brazil's real led a broad surge in emerging market currencies, helping to push the MSCI EM Currency Index to its biggest since March. Despite the big move in the rand, there may be more to come. The currency is deriving sustained support from the 50 percent Fibonacci Retracement line, signaling a gain beyond 11 per dollar from the recent 11.6801 is possible, Bloomberg News reports.


TEA LEAVES
The fallout from the big slump in the bond market isn't restricted to Wall Street. The rise in the 10-year Treasury note yields to their highest since early 2014 means mortgage rates are also on the rise. Indeed, the average rate of a 30-year mortgage has jumped to 4.32 percent from last year's low of 3.78 percent in September. Investors and economists will get a sense Thursday of whether the sharp increase is starting to dent demand for housing when the National Association of Home Builders releases its monthly sentiment index for February. The median estimate of economists surveyed by Bloomberg News is for the index to remain unchanged at a reading of 72, unchanged from January. That would keep it near the highest level since 1999.

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