The “Treasury yields” factor
The yield on the benchmark 10-year Treasury note has dropped to an unusually low level and is standing in defiance of expectations that interest rates were increasing.
After the Fed released minutes from its most recent meeting, the yield was at 1.32 percent.
Instead of a bounce higher, investors are looking at a chart pattern that would bring the 10-year yield closer to 1.2 percent before it could stop falling.
“It’s a repositioning of some of the macro trades that were out there,” said Jim Caron, Morgan Stanley Investment Management’s head of macro strategies for global fixed income. The 10-year yield had been rising earlier in the year, reaching 1.75 percent in March, as investors bet on higher inflation and an economy firing on all cylinders.
Slower growth is on the way.
Growth was expected to peak in the second quarter, and now investors are anticipating a period of slower, but still strong, growth.
According to the analysts/Analytics Moody’s Rapid Update of economists’ forecasts, the median outlook for growth in the second quarter is 10.5 percent, with the third quarter forecasting 8 percent and the fourth quarter forecasting 6 percent.
Economic reports have been generally positive, including June’s employment report, which showed 850,000 new jobs. However, the June ISM services index fell more than expected, causing the bond market to tremble on Tuesday. It was reported to be 60.1, a decrease from 64 in May. The employment component, on the other hand, fell to 49.3, indicating a contraction.
“What we’re realizing is that the data will be good, but the question is whether it will be good enough. According to the market, it is not,” Caron stated. “We had this extraordinary ramp up in monetary and fiscal policy… I believe some of those macro reflation trades are being unwound… Normally, this would indicate, ‘Oh my God, it’s all over.’ I don’t believe so.”
“I think we need to repace or reset ourselves from the fiscal side’s push in growth and inflation to the private sector,” he added. “This is the transfer of stimulus from the public to the private sectors. It all comes down to demand, which is now being generated by the private sector.”
Bond purchases have increased.
Bond yields move in the opposite direction of bond prices. According to strategists, buying picked up steam near the end of the quarter as investors reassessed the reflation trade. Repositioning, short covering, and foreign demand are driving the sharp drop in rates. Rates are also falling in Europe.
The 30-year yield, at 1.93 percent, has also been falling sharply, but the 10-year yield is the most closely watched because it is the benchmark and influences mortgages and other loans.
According to Caron, one positive is that credit markets have benefited and high-yield corporate debt yields have fallen.
The 10-year yield is also closely related to the stock market. In recent months, it has served as a sort of divining rod for tech and other growth stocks. When the 10-year yield falls, technology and growth tend to outperform.
“It’s a tidal wave. “This is a huge wake-up call,” said George Goncalves, MUFG Securities’ head of US macro strategy. He stated that there are various types of Treasury investors, and that some “accounts did not have in their annual forecast that we were going to 1.20 percent before we got to 2 percent.”
As a result, many investors have scrambled to add to their positions.
According to Goncalves, investors held on as the yield fell below 1.6 percent last month, then 1.5 percent, then 1.4 percent. As a result, investors were compelled to purchase Treasury bills in order to cover their short positions.
“Right now, there is pain involved. Something is happening that is forcing people’s hands. “There is skepticism that we will stay meaningfully below 1.50 percent, let alone 1.40 percent,” Goncalves said. “People were holding back, expecting the recovery to continue. When we broke that, it’s likely that a lot of investors rethought their fixed income allocations. Investors were underweight.”
Goncalves reduced his year-end call for the 10-year yield to 1.75 percent from 1.875 percent on Wednesday, but he believes the decline will be short-lived.
Some strategists have predicted market volatility when Congress addresses the debt ceiling later this year, but Goncalves believes it is too early for the market to reflect that.
“Everyone was just overjoyed. That’s all there is to it. It has been demonstrated that the Treasury is not the best place to bet on the economy improving,” he said. “It has limits in terms of how far it can go unless the Fed is hiking, which they are not.”
Strategists are keeping an eye on a 1.21 percent to 1.22 percent level on the 10-year yield chart.
“If it can reach 1.25 percent, there’s little stopping it,” said Ian Lyngen, head of US rates strategy at BMO Capital Markets. “We’re establishing a lower rate range with very little on the macro front to discourage a continued grind.”
This is how regulation could hurt Chinese stocks
Hedge fund manager Dan Niles told analysts on Wednesday that as a consequence of the heightened regulatory enforcement, he is leaving China-based businesses out of his stock portfolio.
“They’ve been steadily increasing the pressure on technology companies, in particular, and we looked at that and said, ‘You know what, you’ve got headline risk every day.’ And for the time being, we’ve gotten out of them,” said the Satori Fund’s founder and senior portfolio manager on “Closing Bell.”
While some Chinese tech firms may have a solid financial outlook, Niles believes the stocks are very sensitive to reports of additional regulatory scrutiny, making them difficult to own.
On Tuesday, for example, Tencent Music Entertainment, JD.com, and Alibaba faced selling pressure as investors reacted to Chinese regulators limiting the availability of ride-hailing giant Didi Global.
Didi fell 4.64 percent to $11.91 per share on Wednesday. Didi shares closed at $14.14 apiece on their first trading day on the NYSE a week ago.
Some Wall Street analysts have suggested that the Didi debacle may cause investors to reconsider investing in Chinese company IPOs.
According to Niles, the recent developments are a continuation of a trend that began with the suspension of Ant Group’s blockbuster IPO in November.
“We were clearly wrong… earlier when we thought things had reached a low point, and then the Chinese government ramped things up again in terms of going after these companies,” Niles said. “So, we’ve decided, you know what, for the time being, they haven’t gotten cheap enough for us to try to catch the falling knife, as it were. We no longer own any of them.”
In early April his fund was buying shares of Chinese internet giant Baidu in an attempt to profit from the Archegos Capital Management debacle.
“We still like it,” Niles said of Baidu on Wednesday. “We hope to reclaim it at some point, but we’ll see when the headlines in China stop getting worse, I guess. There are a lot of great companies in the United States that you can own and not have those issues with.”