- Dollar and sterling reign supreme in rising yield environment
- Stock markets calm overall, but tech sector gets purged
- However, yields fall back on Tuesday, cooling dollar while lifting stocks and gold
Epic rotation within markets continues
While the overall stock market did not retreat much yesterday, that masks the seismic rotation happening under the hood, away from tech shares with bloated valuations and towards value and cyclical plays that might shine as the global economy re-opens. It is not every day that the Dow Jones hits a new record high at the same time that the Nasdaq is 10% away from its own peaks and falling.
It all comes back to bond yields. Yields are essentially the price of money, so they are crucial for equity valuations produced through various models. If yields are rising, the discount rate most of these models use is higher, reducing the net present value of that investment today. A tech/growth share trading at 100x earnings might make sense if long-dated yields are very low, but as they rise, that valuation is no longer rational.
In other words, now that investors can get a better return on safe assets like bonds, taking a massive risk in tech names with sky-high valuations is not as attractive. Hence, most of the tech sector got scorched yesterday while beaten-down value names came back to life.
Ultimately, this seems like a healthy correction after a relentless rally in tech last year. While higher yields may force some players to continue to de-leverage, the overall economic picture is very favorable. Rates are still very low historically, tremendous federal spending is about to hit the US, and the global vaccination campaign is in full swing.
Dollar and pound against the world
Although rising yields are a curse for tech stocks, they are also a blessing for some currencies as widening rate differentials between economies come back to the spotlight. The dollar and sterling have been the biggest beneficiaries of this paradigm shift, capitalizing on weakness in the euro and yen.
In a nutshell, America and Britain are miles ahead in their vaccination programs, sparking expectations that their central banks will raise rates before anyone else. Both the Fed and the Bank of England seem comfortable with this repricing, viewing it as a natural market reaction to a brighter economic outlook.
In contrast, the ECB is stuck with a fragile economy and a slow vaccine rollout, and yet euro area bond yields are still rising, caught in the global storm. Higher yields mean higher borrowing costs, so this threatens the recovery. The implication is that the ECB may take action to shoot yields down, whereas the Fed and the BoE will only intervene if things really get out of control.
The dollar is on the retreat early on Tuesday, surrendering some of its latest gains as global yields pull back, which is also allowing stock markets to breathe a sigh of relief. That said, this seems like a retracement within a broader dollar-positive trend, not the beginning of a bigger reversal.
Gold battered and bruised
In the commodity arena, gold has been the biggest fatality of the dollar’s revival and the rally in real yields. Bullion offers no yield to hold and is priced in dollars, so the higher yields go the less attractive it becomes, and the more the dollar appreciates the more expensive it is for foreign investors to buy the yellow metal. This might be the worst of all worlds for gold.
The retreat in yields and the dollar today has helped bullion to rebound, but the chart is a horror show from a technical perspective. The prospect of one ‘last hurrah’ is still alive as we approach the summer and inflation takes off, but the bigger picture seems bleak given the overarching theme of Fed normalization.
As for today, the economic calendar is low-key. The only noteworthy event is a speech by BoE chief economist Haldane at 13:00 GMT.
