Take Five: Testing times
March 5, 2021
1/LITMUS TEST
On February 25, as a mini-tantrum raged on bond markets, the U.S. Treasury auctioned $62 billion in 7-year notes – but investors, it would seem, forgot to show up. The lowest bid-cover ratio of 2.04 on record sent 10-year Treasury yields rocketing to a one-year high above 1.61%.
The Fed signalling it is not perturbed by rising yields has markets fretting again. Scheduled 10-year and 30-year Treasury bond sales on Wednesday and Thursday will be what TD Securities dubs a “litmus test for potential market dysfunction”.
The first aims to raise $38 billion, the second $24 billion. Another $58 billion of three-year notes are auctioned Tuesday.
The Fed clearly believes any inflation rise is transitory and tighter financial conditions so far don’t warrant action. The outcome of the auctions might well test its resolve.
Graphic: U.S. yields and dollar – https://fingfx.thomsonreuters.com/gfx/mkt/qmypmwzgkpr/US%20yields%20and%20USD.JPG
2/DON’T PUSH IT
From Frankfurt to Rome and Madrid, government borrowing costs are up as much 33 basis points this year so Thursday’s European Central Bank meeting will be a test of its ability to suppress bond yields.
As higher yields risk derailing a fragile euro zone economy, markets want action, or at least a commitment to step up bond buying via the 1.85 trillion-euro Pandemic Emergency Purchase Scheme. Not doing so risks accelerating the selloff.
Almost a year ago markets, already alarmed by COVID-19, took fright at ECB President Christine Lagarde’s off-the-cuff remark that the bank wasn’t there to “close spreads”. Soaring yields forced the ECB to respond with the PEPP.
The anniversary is a reminder to the ECB: it never hurts to show markets now and then not to push it too far.
Graphic: Move in 10-year sovereign bond yields this year – https://graphics.reuters.com/GLOBAL-MARKETS/xegpbwrazvq/chart.png
3/CHINA’S GREAT WITHDRAWAL
Premier Li Keqiang kicked off the annual, week-long National People’s Congress (NPC) with his 2021 report, restoring China’s annual economic growth target set for above 6% this year.
But the bigger question is how does Beijing withdraw pandemic stimulus and avoid asset bubbles without upsetting the economy and twitchy financial markets.
Chinese stocks and government bonds sank this week after its top banking regulator warned of bubbles overseas and rising lending rates.
Trade and money supply data due out will show just how uneven the economy still is and froth levels in the banking system. Markets will watch the NPC closely for clues ahead.
Graphic: China TSF, GDP and markets Image – https://fingfx.thomsonreuters.com/gfx/mkt/12/6912/6843/Pasted%20Image.jpg
4/ARK AGROUND?
After the slide in tech stocks, one fund that bears watching is Cathie Wood’s $23 billion ARK Innovation fund which has fallen more than the market in recent days. Wood shot to prominence with outsized bets on companies such as Tesla and Square that surged during the pandemic. Lipper data shows she attracted $14.84 billion in inflows over the past 12 months.
But tech companies are acutely sensitive to higher bond yields, leaving the ARK fund — and others like it — vulnerable to a performance hit and outflows. Wood’s heavy exposure to illiquid stocks could turn out to an issue.
Graphic: ARK Innovation’s holdings hammered in Nasdaq drop – https://graphics.reuters.com/USA-STOCKS/ARK/nmopazgxdva/chart.png
5/DARK HORSE EUROPE
European and U.S. equity returns are running neck-and-neck in 2021 but after five years of underperformance, European stocks may have just enough tailwind to win the 2021 race.
The old continent being light on tech, isn’t on the front line of the bond selloff which has hit the rate-sensitive Nasdaq. In fact, for investors seeking to ride the reflation trade, Europe ticks a lot of boxes, being heavy with commodities, financials and other value stocks.
U.S. 10-year Treasury yields around 1.5% match the S&P 500’s dividend yield. Europe’s risk-free equivalent, the German Bund, meanwhile pays -0.3%, nowhere near the 1.8% dividend yield on EURO STOXX.
Analysts forecast European earnings growth to beat the U.S. every quarter in 2021. So 43.8% versus 21.6% in Q1 and 79.1% versus 50.9% in Q2.
Graphic: Earnings U.S. vs EU – https://fingfx.thomsonreuters.com/gfx/mkt/oakperklkvr/Pasted%20image%201614869057027.png
(Reporting by Sujata Rao, Dhara Ranasinghe and Julien Ponthus in London; David Randall in New York and Andrew Galbraith in Shanghai; compiled by Sujata Rao and Karin Strohecker)