Asia Open: The higher for longer struggle

Markets

Stocks continue to struggle with the prospect of higher-for-longer interest rates. Recently, a consensus of two more 25 bp rate hikes has shifted to a fully-priced 75 bps of tightening, with some chatter of a 50 bp move. 

With that, 2-year Treasury yields pushed up to 4.84% this week, the highest level since 2007, while the 10-year pushed back toward 4%. ; This will continue to weigh on equity valuations, which have already been under pressure to adjust to the higher rate environment.

Still, US stocks are little changed Tuesday but down ~2% for the month; investors reacted to a somewhat less market-friendly growth/inflation narrative and a decidedly mixed set of 4Q22 earnings results.

In February, rally wagons paused in the face of market participants better aligning with the Fed higher for longer mantra. At the same time, the weight of significant market gains in January is at least partly to blame for the pullback. 

The S&P 500 is still up ~4% YTD. And two of the cornerstones of the global growth reacceleration trade are also still in place: China's reopening and Europe's winter that wasn't, and we should get positive confirmation on China today via the PMI, but the big question is how far above the expansion/contraction demarcation level(50) will the data print.

But the third leg of the global growth narrative -- a US economy soft landing -- took a more tangled turn with an uptick in inflation, some hawkish comments from the FOMC, and a move up in rates -- yields on 10-year US Treasuries are up ~40bp on the month to 3.93%. 

Importantly for the US, however, the growth picture does remain solid. 4Q earnings season showed few signs of a looming recession; the January Payrolls report was surprisingly robust but perhaps far too robust for the Fed in the face of hotter-than-expected inflation gauges for January. 

Finally, for the month, sector performance paints an even more nuanced picture of what is moving stocks at this point in the post-post-pandemic era: alpha. For example, the rise in rates did not necessarily benefit Financials -- a sector that is tracking in line with the broader index, down 2% for February. And the rise in rates did not hurt Tech -- the best-performing sector in the S&P 500 for February and the only sector that gained ground: up 1.5%. And the broader Nasdaq 100 also reflects this outperformance -- down only 0.5% for the month.

On the negative side, Energy was the worst performer this month -- down 7% -- helped along by a 2% decline in front-month oil prices but also likely by the laggards-to-leaders trade -- a factor that is also likely helping to drive up Tech stocks. 

So, when you pull back February's covers, it's not entirely interest rates driving markets at the single stock level but rather a laggards-to-leaders trade that is still chugging along in what might still be the relatively early days of a market recovery.

Forex

Month-end US dollar demand put to rest, at least temporarily, the bounce in the GBP and EUR after a Northern Ireland Brexit deal was finally sealed.

Equity performance has been mixed this month as a string of robust US data has put upward pressure on yields. The Euro Stoxx 50 and the FTSE 100 are relative outperformers (roughly flat in USD terms). As a result, month-end rebalancing models that adjust relative equity market returns for cross-border holdings and liquidity point to downward pressure on GBP & EUR as portfolios are rebalanced. 

Although FX traders have turned agnostic on inflation, if you still think inflation will come down the rest of the year, you could not ask for much better levels to put on short USD or long bonds. 

Commodities are weak in February; thus, the tremendous inflationary impulse we saw in January could be a one-off.