By Jamie McGeever
ORLANDO, Florida- As implied US interest rates revisit their cycle highs from last year and bond yields break out to fresh 2024 peaks, stocks may be at risk of getting vertigo.
Yet the safety net, if required, could also come from the fixed income world – bond market volatility.
Or more precisely, the lack of it.
A calm bond market is critical to the well-being of all markets, as all borrowing costs, from consumer credit cards to corporate debt, are referenced against Treasury yields. Higher volatility generally forces investors to demand a higher risk premium, which lifts the discount rate on all financial assets.
The ICE BofA MOVE index of implied US Treasury market volatility last week fell to its lowest in two years. It has picked up a bit this week as bond selling has accelerated, but remains well below where it was last October when the 10-year yield was shooting up to a 16-year high of 5.00 percent .
This relative calm may quickly evaporate if inflation fears intensify, in which case a drawdown in stocks would almost certainly follow. And Wall Street is primed for a cooling-off period – the S&P 500 and Nasdaq are at all-time highs, having surged as much as 30 percent from their October lows.
But if yields are being lifted by stronger growth more than bubbling price pressures, equity investors can feel reasonably confident that pullbacks will be shallow and short-lived.
“If uncertainty about the Fed evaporates, confidence creeps back in. The ‘soft landing’ views align, bond volatility falls and investor sentiment rises,” says Jeroen Blokland, head of research at investment research platform True Insights.
Strategists at Bank of America note that on average since 1929 the S&P 500 has had 5 percent daily pullbacks three times a year and 10 percent corrections once a year. The index has not had a 2 percent pullback in over 100 trading days, so a meaningful drop is probably due soon.
But that would only provide more attractive levels to add exposure. The longer-term view – solid economic growth, promising earnings, disinflation and rate cuts on the horizon – remains the same.
“Not to forget, the settle down in bond volatility that kept us on our toes last year,” they wrote in a note last week.
Rates volatility has been on a downward path this year, despite nearly 100 basis points of implied rate cuts being wiped off the 2024 US rate futures curve and the 10-year Treasury yield rising around 50 bps.
