The week ahead: Bond yields and earnings reports

The 10-year US Treasury yield continues its march towards 5%, the yield surged by 30 basis points last week, which triggered a decline in risky assets like stocks. As we have mentioned in previous notes, the correlation between the S&P 500 and US Treasuries is at a record high. This means that stocks and bond prices (bond prices move inversely to yields) are both tanking at the same time. For reference, the correlation is at its highest level since the late 1990s, and this may get even stronger in the coming weeks, if bond yields continue to rise. There will be a test for the market this week, can strong earnings reports for Microsoft, Alphabet, Meta, and Amazon, all slated for this week, help to boost the overall stock market even if bond yields continue to rise? 

The drivers of Treasury yields 

Looking at bond yields first, there are some concerns that investors who have held out the bond market storm and kept their long positions are now starting to capitulate. Positioning in US Treasuries is still long overall, but actively managed money has started to go short Treasuries, probably as a result of the sustained period of decline for bond prices, as yields have surged. This leads to a few questions; when the active money finally throws in towel, is this a contrarian signal to go long, due to better risk/ return profile, or does it indicate something more sinister could be at play and another significant leg higher for yields is on the cards? To answer this question, we need to understand what is driving bond yields higher. Is it the prospect of higher for longer interest rates, although we have known about this for some time, and Fed chair Jerome Powell sounded less hawkish when he spoke at the Economic Club of New York last week? Instead, could it be the term premium? Term Premium, which reflects everything other than baseline expectations for short term interest rates from the Federal Reserve, includes the long-term inflation outlook as well as bond supply and government spending plans. This premium has surged in recent months, after being negative for most of the 2010s. The ACM model, which measures the term premium, has been moving higher since 2020 and is now at its highest level since 2008. 

Are we at peak US Treasury yields 

While some people believe that this shift in the term premium is driving yields higher, others are less convinced and instead argue that bonds do not live in a vacuum, and that 10 year and 2-year yields are both tied to each other closely and tend to peak together. Thus, last week’s movements in 2-year yields are worth watching. The new high in 2-year yields last week at 5.26%, was met with a bout of bond buying on Friday, that helped push the 2-year yield down to 5.11%, which is where it closed at the end of last week. While it is too early to call the peak in 2-year yields, there could be some fatigue setting in, with the market unwilling to push the shorter end of the curve higher from here. Since short and long dated bond yields tend to peak together, then we could be close to the peak for longer dated bond yields, and we may see some downward pressure on 10 year yields emerging this week. Added to this, some Fed members have suggested that a rising term premium could limit further interest rate hikes from the Federal Reserve, so a rising term premium could be just the tonic to help ease further bond yield increases. We live in confusing times! 

Tech earnings: a long way to fall 

Looking at the earnings reports for this coming week, tech will be in focus. Projections for big tech earnings growth vary by company. For example, Apple is expected to report 4.8% earnings growth for Q3, while Meta and Nvidia are expected to report earnings growth 116% and 468%, respectively for Q3. Investors are still looking for further signs that the AI boom is translating into profits. This is important for Meta and Nvidia, the latter of which does not report earnings for another month, although Microsoft and Alphabet also use AI to a lesser degree.

The earnings reports from the tech titans are important for the overall market, since they make up 30% of the S&P 500’s market value, up from 22% at the end of 2022. Also, tech stocks tend to have a higher P/E ratio compared to the rest of the index. Tesla’s P/E ratio was 55 times forward earnings last week, while Microsoft and Apple have P/E ratios of 28 and 26 respectively, which are both higher than their 10-year averages. Tesla reported weaker than expected revenues last week, at $19.6bn vs. $21.3bn in Q2, and it also announced a delay to its cybertruck, which is beset by problems. The market was in no mood for disappointment, and Tesla shares plunged more than 15% last week. This could be a sign that tech stocks with high valuations who do not deliver when it comes to earnings could get a beating from the market in the coming days. 

Are we at peak Treasury yields, the dollar thinks so 

Elsewhere, the ECB meets later this week, and they are expected to remain on hold. After weak German inflation data, we expect the ECB could be the most dovish of the major central banks. We also have US durable goods orders and the preliminary October PMI reports for the UK, Eurozone, and the US. The week will round off with September’s core PCE report from the US, the Fed’s favoured measure of inflation. It is expected to edge lower, but any surprise in either direction will likely cause a big market reaction across asset classes. Also worth noting, geopolitical tensions continue to put upward pressure on gold, which rose more than 3% last week, and is edging closer to $2,000 p/ounce. In the FX space, the latest move higher in US yields wasn’t followed by a rally in the US dollar, the dollar index fell nearly 0.4% last week, which suggests that we could be near a short term peak for the USD. It may also be a sign that we are close to peak Treasury yields, so watch this space.