Yields and stocks are at the mercy of the bond market

The FTSE 100 hit its highest level in over a year this morning. Trading above 6,920 the FTSE is at its highest since the pandemic struck and global stock markets plunged at the end of February 2020. The blue chips are back at last: UK equities entered 2021 at a big discount to peers but have not enjoyed the same bounce as US or some European markets. The FTSE 250 is also at a record high – at last UK equities are bouncing strongly on a combination of strong UK growth expectations, ongoing monetary policy support and expectations for a strong global recovery. The move comes after another positive session on Wall Street sent the S&P 500 to another all-time closing high. Yields are supportive after the minutes from the Fed’s meeting in March showed policymakers are no hurry to taper or tighten monetary policy.

Fed minutes gave bond vigilantes little to fight about. Policymakers noted it “would likely be some time until substantial further progress toward the committee’s maximum-employment and price-stability goals would be realized and that ... asset purchases would continue at least at the current pace until then”. Several participants also noted the need to communicate any change in policy well in advance, which suggests the Fed will give the market plenty of lead time before removing stimulus. “A number of participants highlighted the importance of the committee clearly communicating its assessment of progress toward its longer-run goals well in advance of the time when it could be judged substantial enough to warrant a change in the pace of asset purchases,” the minutes read. Lately the benchmark 10yr yield has retreated from its one-year highs struck at the end of March, but this has been more about the pullback in inflation expectations as it has been about Fed communication. The 5yr breakeven inflation rate has retreated from a 13-year high but remains above 2.5%. And this speaks to the fact that yields and therefore stocks are at the mercy of the bond market. In many ways it’s less about the Fed these days than it is about the bond vigilantes.

Jamie Dimon, CEO of JPMorgan, said in his annual letter to shareholders that the US economy is set for a boom that “could easily run into 2023”. As for markets, well he thinks stocks are probably ok. “While equity valuations are quite high (by almost all measures, except against interest rates), historically, a multi-year booming economy could justify their current price,” he wrote. “Equity markets look ahead, and they may very well be pricing in not only a booming economy but also the technical factor that lots of the excess liquidity will find its way into stocks. Clearly, there is some froth and speculation in parts of the market, which no one should find surprising.” Moreover, he points out that a booming economy will make it all so much easier for the Fed to reduce accommodation – what a change from the post financial crisis period when central banks struggled in vain to spur inflation and growth as their bond purchases pushed on a string. “A booming economy makes managing U.S. debt much easier and makes it much easier for the Fed to reverse QE and begin raising rates – because doing so may cause a little market turmoil, but it will not stop a roaring economy,” Dimon says.

Oil prices struggled after the US Energy Information Administration reported crude stockpiles declined by 3.5m barrels last week, which was more than expected. However, a rise in gasoline inventories of 4m barrels left the market somewhat concerned about demand growth as the US gears up for the key summer driving season. WTI (May) continues to struggle for bid above $60 and this morning trades at $59.30.