Dilok Klaisataporn
Longer rates (TBT) (TLT) are still on the march higher Friday after passing a major milestone in the previous session. But the “pain trade” that would weigh on stocks could ultimately hasten the end of the recent bear.
The 10-year Treasury yield (US10Y) is up 6 basis points to 4.29% in early trading. On Thursday it closed at its highest level since 2008, before the Financial Crisis sent yields tumbling. The 10-year real yield (TIP) hit a post-2009 high following a drop in jobless claims and more hawkish Fed chatter (Philly Fed President Patrick Harker sees rates well above 4% by year end.)
It’s the longest decline in Treasury prices since 1984.
On the heels of that, fed funds futures also broke new ground, pricing in a terminal rate for 2023 above 5% for the first time this cycle.
“Bear in mind that on the day of Chair Powell’s hawkish Jackson Hole speech in late-August they closed at 3.78% for the March meeting, so the stronger-than-expected inflation prints over the last couple of months have led to a big reappraisal in how hawkish the Fed and other central banks are expected to be,” Deutsche Bank strategist Jim Reid wrote.
March to 4.50%: There is little in the way of continued Treasury selling that would push yields even higher, with markets seeing a “pain trade” of higher rates and tighter market conditions, ING economists wrote in a note.
“With the effective fund rate now discounted at 5%, there is a path for the US 10yr to get to 4.5% (with 50bp through at the extreme in the past, when the funds rate peaks),” ING said. “It does not need to go much above this, provided the terminal rate discount does not continue to ratchet higher, and there are no guarantees there.”
ING said the only thing containing a much strong spike in yields is the reserve status of the U.S. dollar (USDOLLAR) (UUP). The dollar index (DXY) is up again this morning and approaching its 52-week high.
“For the US the mighty dollar remains everyone else’s problem and is reflective of net capital flows; it’s also containing the rise in US Treasury yields. Had it not been for the buffer being offered by the flight into Treasuries and US assets (in a relative sense), Treasury yields would be much higher than they currently are.”
Stocks washout?: Higher yields put sharp pressure on growth stock valuations but so far there has been equity resilience, with what strategists are calling a bear-market rally sparking following the hot CPI.
The S&P 500 (SP500) (NYSEARCA:SPY) has successfully challenged its 200-week moving average and 50% retracement levels around 3,600-3,500.
But round numbers do tend to matter to the market and the megacap stocks, with their outsize influence, are susceptible to rising rates. Just a year ago, Apple (AAPL), Amazon (AMZN), Microsoft (MSFT), Alphabet (GOOG) (GOOGL) and then-Facebook (META) moved into correction territory as the 10-year yield rose 30 basis points to 1.5% in a month. In the past month, the 10-year yield (US10Y) is up nearly 70 bps.
Megacaps at these valuations are also in fairly uncharted territory with real yields so high.
All those companies report earnings next week. Any weakness, especially in guidance, accompanied by climbing yields could bring sharp selling. A break below technical levels could push the S&P down to the 3,300 levels that strategist have identified as a reasonable bottom for equities.
Megacaps are struggling in premarket today following a big revenue disappointment from Snap. (Which Big Tech stock do you think will be the darling of 2023? Vote in our poll.)
