Global markets continue to dance to the tune of rising bond yields, as a swift vaccination campaign and the overload of federal spending that is arriving soon have seen investors bring forward the timeline of Fed rate increases. The US labor market is healing quickly, President Biden’s gargantuan relief package has been approved by the Senate, and America has stepped up its immunization game, administering a record number of vaccines this weekend.
Nonfarm payrolls clocked in at 379k in February, more than double compared to the forecast of 182k, pushing the unemployment rate slightly lower. This is rather impressive considering that the report reflects a period before the vaccination program was firing on all cylinders and before the spending barrage from Congress was unleashed properly. Hence, even better days might lie ahead.
Encouraging economic news is not always good for financial markets though, as an improving outlook implies that the Fed might take the cheap-money punch bowl away sooner. The Fed has promised to run the economy hot this time, but if the trillions in spending deliver an unprecedented economic boom that lasts for some time, normalizing rates could become appropriate before very long.
This is what the bond market seems to be pricing in. The yield on 10-year Treasuries is trading above 1.6% this week, with the first Fed rate increase being priced in for late 2022/early 2023. This has tremendous implications for currencies and equities.
Return of king dollar?
In the FX theater, the Fed repricing is a natural blessing for the dollar as yield differentials widen in the reserve currency’s favor. This is especially true against the yen since the Bank of Japan keeps a ceiling on Japanese yields, exacerbating this widening spread in relative interest rates.
Indeed, the dollar is cruising higher against most of its rivals on Monday. The euro is particularly heavy, perhaps as traders position for a more dovish ECB this week. The ECB is highly worried about this spike in yields, even though it might be too early to fight it. From its point of view, this is an American story spilling over into the European bond market for no good reason.
The exception is the British pound, which is even outperforming the dollar. The Bank of England has taken a similarly relaxed stance to the Fed lately, showing no real concern even though longer-dated UK yields have quadrupled this year. The euro and the yen might be in trouble in this rising yield environment, while the dollar and the pound could shine even brighter.
Tech exorcism, but broader market still fine
Meanwhile in the stock market, things are still shaky. Both the S&P 500 and the Nasdaq closed a volatile session higher on Friday, drawing strength from the solid US employment report, but futures point to another negative open on Wall Street today as higher yields take their toll.
Bond yields are essentially the price of money. If yields are low, investors are more likely to deploy funds to riskier plays like stocks, but if yields are rising then equities are no longer as attractive. This is especially true if valuations are stretched, hence why the tech sector has taken a beating.
Overall, this seems like a healthy correction, not the beginning of a crash. Powerful fiscal stimulus is coming, the Fed will remain loose for a long time, and vaccines are being distributed quickly. The market might scream, but ultimately long-dated yields below 2% won’t break much. The selloff has been mostly isolated to the tech sector so far, where some air coming out of bloated valuations is probably healthy. Finally, WTI oil prices hit their highest level in two-and-a-half years today, after a missile attack against Saudi Arabia sparked fears of production disruptions.