Last week, volatility in bond yields remained a key driver for equity market sentiment. In particular, mid-week commentary from US Federal Reserve (Fed) Chair Jerome Powell was a key talking point. Whilst headline moves for global indices were muted, the MSCI World Index was up 0.1% and there was significant rotation between asset classes and sectors. On the week, the Stoxx Europe 600 Index closed up 0.9%, the S&P 500 Index up 0.8%, and the MSCI Asia Pacific Index down 0.3%.1
US Yields Continue to Rise as Powell Fails to Settle Nerves
As with recent weeks, the US bond market drove equity market action last week, with Powell’s speech prompting US bond yields to move sharply higher and equites to decline.
Speaking on Thursday, 4 March, Powell stated that whilst current conditions in the US economy ‘could create some upward pressure on prices’, these effects would likely be temporary and would not require additional action from the Fed. He did not feel the current climate risks runaway inflation, as seen in recent history. Powell said: ‘At the Fed, we are well aware of the history and how it happened, and we’re not going to allow it to happen again. It was a situation where the Fed didn’t step in when it should have, when inflation pressures were building. That’s not at all the current situation’.
Some had hoped he would suggest the Fed would be more willing to take steps to halt the recent rise in bond yields; however, he merely commented that the recent moves were ‘notable’. Whilst nothing he said was that surprising or controversial, this lack of action over recent yield volatility spooked some investors, and we saw some aggressive market moves on Thursday of last week. Notably, there was a continuation of rotation out of assets that benefit from low interest rates and into areas that may fare better in inflationary conditions.
The US 10-year Treasury yield traded above 1.6% and yield-sensitive momentum/growth stocks slumped, whilst value names, which would fare better in an inflationary environment, held up better. On the week, the US 10-year yield closed at 1.57%.
Last week we also saw Fed Governor Lael Brainard make similar comments, stating that ‘some of those moves last week, and the speed of those moves, caught my eye’ and the Fed would act if it saw ‘disorderly conditions’.
With the US 10-year yield remaining above 1.50%, this is above the average S&P 500 dividend yield and could put some pressure on securities that saw inflows for their income yield in recent times. The TINA (there is no alternative) argument for holding these names will be questioned if US yields remain elevated.
Emerging markets have also seen scrutiny in this environment. Emerging markets tend to fare better when Treasury yields are low, thanks to the higher yields that they generally offer, coupled with the relative low cost of servicing their own debt. As US Treasury yields have risen in recent weeks, we have seen a stalling of inflows into EM assets. The Financial Times highlighted that emerging market assets suffered their first daily outflows since October 2020, with daily outflows of US$290 million last week, vs. daily inflows of US$325 million in February.2
Looking ahead, the European Central Bank (ECB) meets on 11 March and could garner a great deal of attention given current market conditions. The Fed’s policy meeting next week on the 17 March will also no doubt be a huge focus globally.
Energy Markets in Focus
Last week saw some dramatic moves in energy markets, with West Texas Intermediate crude oil up 7.5% to above US$66 per barrel last week after the OPEC+ group ratified a smaller-than-expected production increase. It announced plans to increase production by 150,000 barrels per day (bpd), which was lower than expected. There had also been an expectation the Saudis would unwind some of the 1 million bpd unilateral cut made previously. The Saudis decided to extend their voluntary reduction another month, with the Saudi Oil Minister stating, ‘the only thing that’s certain today is uncertainty’.
Energy markets saw further volatility today following attacks on Saudi oil facilities from Yemen.
The Week in Review
The S&P 500 Index continued its grind higher last week, but as the US bond selloff continued, so did rotation into value and out of growth stocks. With this, the NASDAQ underperformed, down 1.9%, amid weakness in the technology sector. Real estate investment trusts (REITS) and consumer discretionary stocks were also lower on the week. The energy sector was the clear outperformer, up +10% given the move in crude oil. value names rallied, seeing financials and cyclicals outperform.
Feeding into the cyclical strength, US stimulus remains a focus, with the US $1.9 trillion rescue plan passing through the Senate on Saturday. The bill is now back with the House to approve the Senate amendments, and President Joe Biden is expected to sign the bill on 15 March. The COVID-19 relief bills passed in the past year are estimated as totalling 25% of US gross domestic product (GDP).
Macro data was better overall last week and supportive of the reflation trade. The ISM manufacturing Index data beat estimates. The ISM prices paid component was at multi-year highs and ISM delivery times are at the second longest since 1979, providing clear evidence of the disruption to supply chains, which in turn also can fuel inflation.
The headline nonfarm payrolls number in the February US employment report was particularly strong at +379,000, and there was a positive revision of 38,000 to the prior figure. Unemployment fell further (to 6.2%) and average hourly earnings also looked decent at +5.3%, although it was noted in the Fed’s Beige Book report that the shortage of qualified workers had pushed up wages in many areas. This trend appears likely to continue in the coming months.
European equities finished in positive territory last week, with a few moving parts behind the scenes. The Stoxx Europe 600 Index closed the week up 0.9%. Commodity prices joined credit markets as a focal point, with Brent crude oil up 4.5% at the close in Europe last week, on the back of the OPEC+ headlines. Events in the United States have been a key driver of European equity markets of late and Powell’s speech garnered attention in the region.
A particular theme we have seen in the last few weeks is winners being sold (profit-taking), and that was the case again last week. European value was thus up on the week. With the extreme rotation in recent weeks, EU value is now outperforming EU momentum over the past year, which seemed quite unlikely back in October 2020.
UK equities were strong last week. Large value constituents drove gains, along with Chancellor Rishi Sunak’s latest budget. Sunak extended furlough payments until the end of September, protecting jobs and incomes hit by lockdown. He also announced an extension of the stamp duty holiday, which supported the housebuilders.
The FTSE 100 Index closed last week up 2.2%. The FTSE MIB Index was the laggard in Europe, but Italian equities still managed to finish up 0.2% overall. There were reports that Italian Prime Minister Mario Draghi’s administration was ready to distribute €32 billion of extra stimulus. Note, COVID-19 cases are on the rise in Italy, similar to the rest of continental Europe.
In terms of sectors, oil and gas stocks outperformed amid the move in underlying commodity prices. Autos were also strong in Europe following some positive earnings in the space and a series of upgrades. In terms of the laggards, moves in the US market weighed on tech stocks in Europe. As has been standard of late, health care and utilities also underperformed, both down on the week.
Another continuing theme is ‘Reopening’ names faring better than ‘Stay at home’.
Asia and Pacific (APAC)
Performance in the APAC region was more muted, with mixed performances across the region. The MSCI APAC Index closed slightly lower (-0.3%) on the week. Japan’s equity market underperformed as the pandemic-related state of emergency was extended two weeks for the Tokyo region. There was also commentary from the Bank of Japan that made it clear that the central bank’s 10-year yield target is off the table as part of its policy review later this month, which in turn saw Japanese yields tumble.
In China, People’s Republic of China Premier Li Keqiang unveiled a goal of at least 6% growth in 2021, citing the ‘tremendous tenacity’ of the Chinese response to the pandemic and global recession. Some saw the 6% figure as disappointing, but it is important to remember that this is in the context of the Chinese administration’s goal to move away from intervention/stimulus.
China’s top banking regulator warned last week of the risk of bubbles within both international markets and the country’s own real estate space. He said, ‘I’m worried the bubble problem in foreign financial markets will one day pop’, adding that ‘China’s market is now highly linked to foreign markets and foreign capital continues to flow in’. These comments hit Chinese equities on Tuesday last week as they backed up concerns over monetary tightening in China.
China’s commentary was echoed in Australia the following day, as Australian Treasurer Josh Frydenberg warned that global stimulus is threatening financial stability. Australia also defended tough new foreign investment rules that have seen a decline in Chinese investment, arguing that an increasing number of potential deals are being motivated by strategy, rather than purely commercial gain.
Data over the weekend showed that China’s exports surged in the first two months of the year, jumping 61% (in USD terms). The surge may be skewed somewhat vs. an economy in lockdown this time last year, but still reflects strong global demand. Imports also grew more than expected, +22.2% in the first two months of the year.
The Week Ahead
ECB Meeting 11 March: How Will it React to the Rise in Global Bond Yields?
Ahead of the ECB meeting on Thursday 11 March, there has been the usual trail of commentary from various officials, and it looks like the meeting is shaping up to be one of those events that could leave the markets with more questions than answers. In terms of new policy measures, none are expected but the markets will be looking for Lagarde to clarify the ECB’s view on higher government bond yields, to what extent they are consistent with its stated policy aim of preserving accommodative monetary conditions and what, if anything, the ECB will do if market moves become misaligned with economic fundamentals.
- Eurozone fourth-quarter GDP (9 March)
- US consumer price inflation (CPI) (10 March)
- ECB meeting (11 March)
- UK January GDP (12 March)
Monday 8 March
- German Industrial Production
- Bank of France Industry Sentiment
- ECB’s Villeroy speaks
- Japanese GDP
Tuesday 9 March
- Germany Trade & CA Balance
- Italy Industrial Production
- Eurozone fourth-quarter GDP
Wednesday 10 March
- US Core CPI
- China CPI
- Japanese PPI
- Riksbank Rate Announcement: no change expected
- ECB’s Panetta speaks
Thursday 11 March
- ECB Meeting
- European Commission publishes economic forecasts
Friday 12 March
- Germany CPI
- UK Trade Balance & GDP
- Eurozone Industrial Production
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1. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
2. Sources: Financial Times, ’Emerging Markets Suffer First Outflows Since October on Rate Jump’, 5 March 2021.