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High-velocity market swings have roots in economic boom thesis

Stiffening hawkishness at the Federal Reserve started out as a reason to panic in risk markets.

March 27, 2022 / 10:13 AM IST
Photo: Bloomberg

Photo: Bloomberg

At times in the last few weeks, trying to glean a coherent message from disparate swings across asset classes has been an exercise in futility.

Where once surging bond yields and commodity prices spelled big trouble for equities, now stocks are surging alongside them. Stiffening hawkishness at the Federal Reserve started out as a reason to panic in risk markets. Now, even the threat of supersized interest-rate hikes isn’t enough to ruffle Wall Street bulls.

The pivots have been swift, and probably aren’t over. Still, something approaching a unified theme does seem to have coalesced in the latest crop: resurgent faith in the trajectory of growth. Armed with bullish readings on manufacturing and hiring, markets have started behaving a lot like they expect the economy to avoid a contraction and expand.

“The Fed is and has been hiking into a boom,” said Neil Dutta, head of economics at Renaissance Macro Research. “The signs of recession in the U.S. economic data are much like looking for intelligent life on other planets: potential sightings, none confirmed.”

The solid backdrop is hard to dismiss, at least for now. Growth in the U.S. economy accelerated last quarter, while earnings for S&P 500 firms posted double-digit expansions for a fourth straight time. Going by analyst forecasts, corporate profits will increase at about 10% a year through at least 2024. Meanwhile, gross domestic product is expected to rise more than 2% in each of the next six quarters.

Most ways you slice it, a pattern has emerged in markets after the Fed’s March 16 rate hike, one of gains in risk-on assets. Oil has surged 17%, the S&P 500 is up 6.6%, and 10-year Treasury yields are approaching 2.5%, the highest level in almost three years.

A basket of unprofitable tech firms, hammered during the first two months of 2022 as the specter of higher rates weighed on their valuation, reached a low right before Fed’s rate decision and has since jumped almost 30%. Newly minted stocks, many of which have yet to make money, show the same trajectory. An exchange-traded fund tracking recent initial public offerings is up about 20% over the stretch.

To be sure, different explanations exist for each individual move. Oil obviously got a big boost after Russia’s invasion in Ukraine. But the commodity’s rally began months ago in the face of booming demand.

To Peter Tchir, head of macro strategy at Academy Securities Inc., inconsistent asset correlations are the story of markets right now.

“I am struggling to figure out the ‘tell’ in what seems like very confusing, messy and even unusual market,” Tchir said. “I’m old enough to remember when higher yields used to spook big tech stocks (maybe because that was only a couple of weeks ago). Now we seem to be in more of a ‘risk-on’ or ‘risk-off’ mode.”

There are signs for all the burgeoning economic bullishness, investors themselves are not quite convinced. Stock trading volume, for instance, on Thursday fell to a five-week low. Meanwhile, U.S. equity funds suffered their largest weekly outflows in two months, EPFR Global data compiled by Bank of America Corp. show.

Adding to confusion are the conflicting messages from the bond market. A growing list of curve inversions in Treasury yields has stirred up investor angst, with some pointing to a quickly shrinking spread between two-year and 10-year Treasury rates as a warning sign for a recession.

Fed Chair Jerome Powell weighed in on the topic earlier this week, suggesting the central bank prefers a different measure of yield curve -- one that focuses on the short-term Treasuries: three-month relative to 18-month. And that part of the curve has steepened to the widest on record.

“The economy has room to run. I think it’s going to be slower than last year, for sure,” Megan Horneman, chief investment officer at Verdence Capital Advisors, said by phone. “But I don’t think that I’m ready to say that this expansion is over or that we’re headed toward an imminent recession.”

first published: Mar 27, 2022 10:13 am