Friday 21.00 BST. US stocks ended a gravity-defying week at record highs, even as Treasury bond yields held close to levels not seen for nearly a year – although activity was relatively subdued ahead of a series of key risk events next week.
“As was the case before the crash, US equity markets are providing signals about the economy that seem to conflict with those coming out of the other most liquid market in the world, the US bond market,” said Lena Komileva at G+ Economics.
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“Similarly, traditional indicators of uncertainty and market volatility have continued to reach new lows. The result is that too many participants are starting to confuse the decline in market volatility with a decline in overall risk.”
But such concerns appeared to carry little weight on Wall Street – for now at least. The S&P 500 rose 0.2 per cent to 1,923, its fourth record close in five sessions. The US equity benchmark gained 1.2 per cent over the holiday-shortened week and 2.1 per cent for the month.
The CBOE Vix equity volatility index – often called Wall Street’s “fear gauge” – was down 1.5 per cent in late trade and hovering near its 2014 low.
Across the Atlantic, the FTSE Eurofirst 300 edged back 0.1 per cent from Thursday’s six-year closing high but recorded a weekly rise of 0.6 per cent and a monthly gain of 1.8 per cent.
In Tokyo, the Nikkei 225 slipped 0.3 per cent yesterday but rose 1.2 per cent over the week and 2.3 per cent in May as a whole – its first monthly gain this year.
The strong equity market performances came as highly rated US and German government bonds also attracted hefty buying.
The 10-year US Treasury yield – which moves inversely to its price – was up 3 basis points yesterday at 2.48 per cent, but down 6bp over the week. It touched 2.4 per cent on Thursday, the lowest since last June and some 60bp down from the start of year.
Analysts scrambled to explain the conundrum of rising equities and falling yields, which has caught many investors on the hop, given expectations for yields to rise this year as the Federal Reserve scales back its bond purchases.
US data releases have – on the surface at least – pointed to improving economic conditions in coming months, particularly in the labour market.
This week’s downward revision to US first-quarter GDP was attributed by many to sharply falling levels of inventories.
Most economists expected a strong rebound in the second quarter. Further clues on the health of the US economy may come next week with the release of manufacturing and non-farm payrolls figures.
Meanwhile, some strategists argued that the drop in yields had been exacerbated by investors caught out after they positioned for yields to rise.
Others suggested China was buying Treasuries in a move aimed at to weaken the renminbi.
An interesting theory was that bond investors had revised down their estimates of the longer-term natural, or equilibrium, interest rate – the rate consistent with full employment and stable inflation.
“Any estimate is highly uncertain, is unobservable and varies considerably over time,” said Ethan Harris, global economist at BofA-Merrill Lynch.
“Our tentative bottom-line – the real natural rate has dropped from a historic average of about 2 per cent to 1.5 per cent.”
Others said the drop in yields was encouraged by growing speculation that the European Central Bank would unveil a package of easing measures next week – including a negative deposit rate – to counter low eurozone inflation.
The German Bund yield ended the week at 1.36 per cent – up 1bp on the day but 6bp lower on the week. Peripheral eurozone sovereign debt was also in demand.
In spite of such speculation, the euro remained resilient. The single currency was up 0.2 per cent against the dollar at $1.3631 yesterday to stand barely changed on the week.
Petr Krpata, FX strategist at ING, warned that investors expecting the euro to fall on the back of a negative ECB rate could well be disappointed.
“We think such a move from the ECB is likely to cap the euro’s upside, via lower portfolio inflows and the increasing credibility of forward rate guidance, rather than actively driving it down,” he said.
“The other side of the euro/dollar equation – the dollar – has to start working to bring the cross lower. This may still take time.”
The strength of global stocks encouraged heavy selling of gold . The metal was down a further $10 yesterday at $1,244 an ounce – a drop of $48 over the week, its worst five-day performance in two months.
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I'm optimistic about the stock market. Some argue we'll have a correction when we taper QE, but I think most investors already understand this and I suspect that the effects of tapering may have already been priced into current prices. Also, at current unprecedentedly low interest rates, I think equities can go much higher, and historically, when interest rates are as low as they are now PE ratios were much higher. This is why I think the market is still cheap despite new highs.
ReplyDeleteIt would be interesting to observe the impact of negative interest rate in Europe. I believe the Europe, US, and Japan are all having very low interest rates at the moment. I want to see whether negative interest rate will help boost the European economy.
ReplyDeleteI wonder how negative interest rate work though...?