Bond markets continue to be thorn in stock markets’ sides

Stocks are struggling for direction this week, and it’s reflected in their poor performance. In the last 5 days, the S&P 500 is down 0.16%, the Nasdaq is lower by 0.32%, the FTSE 100 is down by 0.6% and the Eurostoxx 60 index is lower by 0.3%. The Dow Jones Industrial Average, which holds mostly value stocks, seems to be immune to this and is higher by 0.75% in the same period. For now, the sell off is mild, but there is a sense of lethargy in global stock markets right now. This is reflected in the breadth of the indices, and the number of stocks that are rallying. For example, on the S&P 500, only 174 stocks advanced on Wednesday, this was a slight improvement on Tuesday, but it is still at extremely low levels. Is this normal half-year end behavior, or is it something more sinister?

On Wednesday, we noted that the bond market was driving sentiment as global sovereign bonds sold off, pushing up bond yields. The sell off has continued into Thursday, and UK 10-year Gilt yields are higher by 3 basis points today, French yields are up by 2 basis points and in the US, the 10-year Treasury yield is up by 1 basis point. The 10-year UK Gilt yield is higher by 13 basis points so far this week. While it may not sound like a lot, this is a big move for the bond market, and it can have a ripple effect on other markets.

Why bond markets matter

A simple correlation analysis can help to illustrate the relationship between bonds and stocks. The UK 10-year Gilt yield and the US 10-year Treasury yield have a very strong positive correlation, and they move together nearly 80% of the time so far this year. This means that when US Treasury yields are moving, the chances are UK Gilt yields will follow, since the Treasury market is the most important bond market in the world. The 10- year Gilt yield also has a mildly negative correlation with the FTSE 100, at -0.5%, and the 10-year Treasury yield also has a negative relationship with the S&P 500 of -0.44%. While these relationships are mild, it does highlight how when bond yields rise, stocks tend to sell off. Interestingly, the Cac 40, has a lower negative correlation with the French 10-year bond yield at only -0.21 so far this year, and this has barely shifted since the announcement of the snap French election earlier this month.  

Inflation in focus

Overall, when bond yields rise, this can spell bad news for stocks. It is also why there is intense focus on inflation data, since it can have a big impact on bond markets. Higher than expected inflation in Australia and Canada this week weighed heavily on global bond markets. Canadian 10-year bond yields rose by 10 basis points on Wednesday. On Friday we get the latest flash inflation prints for the euro area, these are worth watching closely. The Spanish inflation reading tends to be seen as a lead indicator for the bloc, the market is expecting a slight retreat in price pressure, with core prices expected to decline to 2.9% from 3% in May, and headline prices are expected to fall to 3.4% in June from 3.6% in May. If inflation in the currency bloc surprises on the upside, then it could trigger a rise in bond yields, which may erode risk sentiment.

US data watch

There are some key data releases from the US in the next two trading sessions, which could also impact market sentiment. Today we will see the final readings of GDP for Q1, pending home sales and durable goods orders for May, and last week’s initial jobless claims. On Friday, we get the core PCE for May, which is expected to show a moderation to 2.6% from 2.8%. Personal income is expected to expand by 0.4% and personal spending is expected to rise by 0.3% for last month. US economic data is worth watching closely, as hawkish comments from Fed governor Bowman, where she stated that interest rates could remain higher for longer, weighed on interest rate cut expectations. The market now expects a 56% chance of an interest rate cut from the Federal Reserve in September, down from 65% earlier this week. Tomorrow’s PCE data could see another recalibration of rate cut expectations.

Yen in freefall?

The yen is also in focus. As we mentioned earlier this week, the Japanese authorities have not intervened in the JPY and USD/JPY has surged beyond 160 and is currently trading at 160.50. The Japanese authorities would be mad to intervene before tomorrow’s PCE data in the US, incase a downside surprise weighs on the dollar. Also, short term intervention does not work, if the Japanese authorities want a strong yen they will need to either 1, create a long term programme of intervention to strengthen the yen, which will cost many hundreds of billions of dollars, or 2, normalize monetary policy at a faster pace, which could destabilize the Japanese bond market. Neither option is without costs, however, a weak yen is also eroding Japanese purchasing power, which is hurting Japanese households, which is also unsustainable in the long term.

Stocks to watch: Gucci basks in the glory of Taylor Swift

Has Kerring, the French luxury house that owns Gucci, benefited from the Taylor Swift effect? Swift and her boyfriend wore Gucci on a night out in London last weekend, and the shares have risen for 6 straight sessions since. A mixture of Swift’s financial magic and a Bank of America upgrade has pushed the share price higher by 5% on Thursday, as this stock makes a recovery after falling nearly 15% YTD. We are also watching Nvidia, which is down 1% in the pre-market. This stock is incredibly volatile, and much more volatile than the broader market, however, it is an incredibly popular stock for investors, and it is down 10% this week. If this stock experiences further losses, could it trigger capitulation in the retail traders’ market? We shall have to see, but this is a stock that is worth watching.