When will yields hurt?

Summary

  • The big question for European and U.S. stock markets on Thursday is when they may reach their pain threshold. This week has seen recharged inflation expectations drag Treasury yields higher, with borrowing costs on forward rates also joining the party. That means Main Street is preparing for inflation to ‘normalise’, maybe even overshoot over the next few years.

  • Stock markets, diverted by surprisingly resilient U.S. retail data and earnings, have so far put the latest yield-dollar-inflation outlook ramp on the back burner. Europe’s STOXX, Germany’s DAX, the S&P 500 and Japan’s Nikkei have hovered either side of a 0.5% range this week. STOXX, DAX and FTSE were ticking up at the time of writing, whilst U.S. index futures were inching lower.

  • Since equities tend to deal with quickening fixed-income pressure by posting sizeable corrections, perhaps all that’s missing is strong enough trigger. It probably needs to be less easy for investors to dismiss than notoriously volatile retail data out on Wednesday.

  • Even Italian asset markets looked more relaxed on Thursday morning, after beginning to price alarming political prospects in late trading the day before. The FTSE MIB had taken back 0.66% of Wednesday’s 2.3% slide at last look. Italian benchmark bonds kept away from the two-month highs notched on increasing imminence of a 5-Star/Northern League coalition. The sheer outlandishness of some leaked plans helped ease investor concerns a bit. The would-be coalitions’ denials that leaked draft policies were ever concrete plans also helped smooth markets.

  • Investors may muse that political pressures on 5-Star/League could shave further rough edges off their plans. Either way, demand for short and long-dated insurance hedges against more upsurges in debt and euro volatility, is rising. Italian 5-year CDS traded at the highest since January; one-month vanilla euro option volatility spiked to late-February levels. Commentary from 5-Star/League leaders di Maio and Salvini is getting more definitive, but timing of any announcement remains unclear, as is the question of who will be PM.

  • Political risk swung the other way for UK markets. PM Theresa May has not, she says, climbed down on the notion of a customs union beyond 2021, paradoxically finding sufficient courage to climb over cabinet blockers. But the pound is reacting as if that’s exactly what happened. Against the dollar sterling was up 40 pips having peaked at $1.3569 in Asia. Headlines could decide whether cable bases near the lower end of its $1.3576-$1.345 May range.

  • U.S.-Asia news flow also helped disrupt the dollar uptrend. “We’ll see” said President Donald Trump after North Korea got cold feet on talks, complaining about hardball tactics. Chances of historic North-South Korea/U.S. discussions taking place don’t seem dead. The dollar against the yen continued to consolidate below 110.50, supported around its 110.17 200-day average. A break below could be decisive for the greenback’s revival trend. The announcement of official U.S.-China trade talks is a useful offset to Korea. As are reports that a key White House hawk on China, Peter Navarro, has been side-lined. Markets expect no guarantees from talks. That they’re happening at all is dollar-supportive.

  • A sparse corporate release schedule for major equities leaves Wal-Mart’s Q1 report in focus. With evidence U.S. retailers are becoming more resourceful in the fight against Amazon—see Macy’s thrashing of Wall St forecasts on Wednesday—Walmart shares are seeing support this week. The group has a lot on its plate though. It recently bought India’s Flipkart, its biggest ever acquisition, and faces questions around its 45 years of dividend progression side by side with punishing investment needs.

  • After strong NY Fed readings combined with retail data to take investors off guard, Philly Fed updates in a similarly depleted macroeconomic agenda will see enhanced attention. The main gauge is forecast to fall to 21 from 23.2. Forecasters are underestimating U.S. data a lot at the moment.

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