Bond Yield & Equities

Right now there is a bit of confusion in the market. There is a lot of focus on the relationship between the Bond and the Equities market. Bond and Equity correlations are flipping from negative to positive, or back and forth. Morgan Stanley referes to it as a “transition phase”.

Historically, when the 10-year bond yields fall below 3 % for an extended period of time, stocks and bond yields tend to go in opposite directions. That’s more or less been the status quo during the past few years of sub-3 % 10-year yields.

Bond Yield & Equities

More on Bond Yield & Equities from Goldman Sachs: https://brokenmarkets.wordpress.com/2013/05/30/positive-correlation-between-bond-yield-equities/

The Risk On Risk Off Factor

How to create value, wealth. It’s easy, just kill the Yen.

The entire stock market is set in motion on the basis on what happens in the currency market. The “Risk on Risk off” factor right now is definitely the USDJPY.

USDJPY

And where the U.S. goes, Europe follows. The expanation for the move; a story in Reuters about Japan and Japan’s big pension fund being able to move into equities. Moving from JGBs (Japanese Government Bonds) to equities.

Market Performance

Bond Yield & Equities

Correlation between European equity market and moves in bond yield has been positive since 1999. Higher yields have been synonymous with stronger growth (good for equities) while lower yields have been associated with both weakening growth and rising chances of deflation – both poor outcomes for equities. Prior to 1999 the reverse was true; rising bond yields were generally seen as a negative. We attribute this shift in the relationship largely to the level of bond yields and therefore whether there is more to fear from weak growth and deflation (the case in recent years) or from high growth leading to inflationary concerns.”(Goldman Sachs)

Goldman themselves stated that “Inflation has decelerated markedly across the world in the last couple of months”. I don’t see that as a sign of stronger growth. If you’ve driven down interest rates to artificially low levels for an extended period of time, and then start talking about tappering, then I think something is bound to happen sooner or later.

Paul Krugnman: “…..falling bond prices accompanied by rising stocks and a rising dollar. So this looks like a story about macroeconomic optimism.” Is weakening manufacturing data and weakening inflation also a sign of macroeconomic optimism?

Bond Yield & Equities

Inflation: https://brokenmarkets.wordpress.com/2013/05/29/inflation-2/
Inflation: https://brokenmarkets.wordpress.com/2013/05/16/inflation/

Under the Hood

It’s usually said that, as Transports go, so goes the rest of the market. Transporting companies are the first to notice and report any change in the underlying economy. Personally, I’m a firm believer that this rally is liquidity driven. Regardless, it is important to keep an eye on developments and once again Transports are starting to underperform the broader index.

Market Performance

Another warning sign is that High Yield has turned south. It has happened before but it’s still a warning sign that something may be changing. That the market upswing is entering another or a new phase.

Market Performance

Inflation

Inflation expectations are not developing in line with the equity market. If the actual recovery really was strong, self-propelled, wouldn’t inflation expectations be higher? Are we heading for deflation? Inflation has decelerated markedly across the world in the last couple of months. And if inflation falls, especially core inflation, what does that say about the health of aggregate demand.

Inflation

Inflation: https://brokenmarkets.wordpress.com/2013/05/16/inflation/

Bye Bye Austerity

“FT: Brussels will on Wednesday give its clearest signal yet that it is moving away from crisis response based on austerity, allowing three of EU’s five largest economies to overshoot budget deficit limits and pushing instead for broader reform. In its annual verdict on national budgets of all 27 EU members France, Spain and the Netherlands will be given a waiver on the annual 3 per cent deficit limit. Brussels will also free Italy from intensive fiscal monitoring despite its new prime minister’s decision to reverse a series of tax increases imposed by his predecessor.”