For everyone watching the paradoxical dance between rising bond yields and higher stocks with great interest, wondering when the correlation will finally snap, and what happens then, then the latest thoughts from Bloomberg macro commentator, and Lehman veteran Mark Cudmore, will make for a very interesting read.
From Mark Cudmore’s latest Macro View
Tactically Bullish Dollar and Bearish U.S. Equities: Macro View
Treasury yields are not in equilibrium at current levels. If they go higher, the dollar will rise and equities will fall. If they go lower, what happens to other assets will probably depend on what the catalyst for the move was.
This day last year, U.S. two-year yields closed at 1.18% and the 10-year was at 2.37%. At that time, consensus CPI forecasts for 2017 and 2018 stood at 2.4% and the 2019 projection was 2.2%.
Since then the inflation outlook has dropped across the curve. It’s not just that 2017 inflation missed those expectations by 0.3 percentage points. More importantly, we now expect less inflation in 2018 and 2019 than we did a year ago, at 2.3% and 2.17% respectively.
So the inflation outlook has deteriorated and yet two-year yields are more than 100 basis points higher, with the 10-year up more than 50bps. That’s an extraordinary rise in real yields. It was reflected by TIPs yields closing at the highest level in more than four years earlier this week.
Ignoring whether Treasuries are sustainable at this level, one thing is certain: the climb in yields isn’t justified by inflation dynamics.
Coming into February, tax reform, global growth, Trump impacts and fiscal deficits were all being used to explain how equities could continue to roar and the dollar slump even as real yields tightened. All those things have now had a chance to be fully priced in.
Real yields now stand at a critical technical juncture. A break up and there’s nothing left to stop the dollar roaring and equities melting.
- What happens if yields go lower? If the move is led by a retreat in equities, then that’ll cause P&L-destruction that will also squeeze dollar shorts.
- If yields fall because there’s a technical failure at 3% that squeezes Treasury shorts or because investors give up on this idea of accelerating inflation, then expect equities to drop and the dollar to benefit from haven flows.
- The only scenario where equities benefit is one where real yields fall because inflation and growth get rapidly revised up. That would be bad for the dollar.
But where is this sudden, massive boost to inflation and growth going to come from?
So summing it all up: the most likely outcome is a stronger dollar combined with lower equities. Controversially for some, this may be accompanied by lower yields as well.
via Zero Hedge http://ift.tt/2CDSUbQ Tyler Durden