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The law of stock market gravity: the US bond orbits towards the fateful level of 4%

Date: March 24, 2023 Time: 22:54:23

From extreme heat to polar cold. Fixed income markets are stealthily witnessing an extreme change in financial conditions with the gradual withdrawal of central banks from the front line of debt auctions which, in combination with rising interest rates, is pushing up yields of bonds and financing costs. Some experts consider that this is a key factor that puts pressure on companies’ stock market valuations, especially when profits have begun to slow down due to inflation.

The ‘bills’ of the US Treasury at 6 and 12 months yield more than 5% for the first time in 16 years, but there is a price that has lagged behind although it is waking up now, it has put investors on alert for its suggestions on valuations in a bag. It is the 10-year US Treasury bond, whose interest has just risen to its highest since November, close to 4%. This is a level that has coincided in the past with stock market corrections, such as in 2018 or last summer. And an escalation of interests always means a fall in the prices of the bonds, since these move inversely to their profitability.

Bonds rule, do stocks listen?

The inverted curve of the debt in that country – which makes short terms pay more interest than long ones – in anticipation of a recession is once again an anomaly. But investors are facing extraordinary times as their everyday new normal. “The connection between stocks and bonds is one of the most important considerations in making asset prescription decisions. However, it is difficult to estimate reliably and it can change dramatically with macroeconomic conditions,” Pimco points out in a study on the ask

The statistical report notes that over the past hundred years, the monthly connection between the S&P 500 and long-term Treasuries has changed sign (positive or negative) more than 30 times, affected by four macroeconomic factors: real interest rates , inflation, unemployment and growth of the economy. Their conclusion has a lot to do with the current scenario: “We find that stocks and bonds have the same sign sensitivity to the (inflation-adjusted) real policy rate and to inflation, while their sensitivity to growth and unemployment have opposite signs, therefore, depending on which factors dominate, the coincidence can be positive or negative,” they explain.

During 2022, the confirmation was positive between bonds and shares so that wherever one went, the other went. During the previous two decades, the behavior was opposite or negative. What is happening in 2023? A report from the risk rating agency Fitch Ratings seems to hit the mark by recalling a global event that goes unnoticed in the markets, engrossed in the debate on recession and inflation.

“A massive shift in the liquidity flow of central banks is taking place. The combined asset purchases of the Federal Reserve (Fed), the European Central Bank (ECB), the Bank of England (BoE) and the Bank of Japan (BoJ) will be negative by 2 trillion dollars between 2023 and 2024”, says Brian Coulton, managing director of Fitch Ratings.

In a report just out of the oven together with analysts Charles Seville and Pawel Borowski, the debt appraiser warns against the withdrawal of large debt buyers: “This large-scale global quantitative tightening (QT) will be a striking contrast to 2022, when ECB and BoJ purchases outpaced, in absolute terms, the decline in Fed and BoE quantitative easing assets There was another 500 billion QE last year, after more than 5 trillion dollars in 2020 and another 3 billion injected in 2021.

In Fitch’s opinion, the functioning of government debt markets could be put to the test again as the main central banks withdrew liquidity in 2023 and 2024. “The fall in bond prices in response to an increase in the supply Bond prices should be expected as a natural part of the market mechanism. However, the recent UK bond crisis showed the risk of disorderly dynamics, where falling bond prices lead to new selling pressures on debt and stocks,” they add. expertsthese.

The ECB contemplates this possibility and, for this reason, last summer it “prepared for the worst” with the creation of the TPI, a monetary instrument for massive bailouts that will be able to make unlimited purchases of any asset or jurisdiction with certain conditions. With the Ukraine-Russia war raging and governments spending more than they take in, the question seems to be when you will use it.

Fitch foresees turbulence in Europe because the withdrawal of the ECB will be joined by a new ration of public deficit. His analysts estimate an aggregate fiscal deficit for the eurozone of 500 billion euros in 2023, which arose from new issues. This imbalance will have to coexist with a quantitative adjustment -withdrawal of liquidity- of 150,000 million by the central bank. In the US, the situation does not look much better. The Biden Administration faces the need to raise the debt ceiling from 31.5 trillion dollars, but it will also face the Fed, which plans to reach its balance of 700,000 million in bonds and mortgage debt. More arguments against the debt and, by rebound, on the stock market.

Puck Henry
Puck Henry
Puck Henry is an editor for ePrimefeed covering all types of news.

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