- ECB unlikely to fight the spike in yields today, may boost euro a little
- Tame US inflation and solid bond auction calm yields, hurt dollar
- Dow Jones hits new record but tech lags as infrastructure comes into view
Too early for ECB to fight rising yields?
The main event today will be the European Central Bank policy decision at 12:45 GMT. The ECB views the latest spike in bond yields mostly as an American story that’s spilling over into Europe for no good reason, so some senior policymakers have been vocal about ‘fighting’ the move.
However, it might be too early for that. While some officials have called for an immediate acceleration of QE purchases to push yields back down, several others have downplayed the need for immediate action, suggesting they can manage this risk simply through verbal intervention for now. Simply threatening markets with action may be enough at this stage.
Higher yields raise the cost of borrowing in the economy, which can hold back the recovery if the moves are excessive. It essentially negates much of the ECB’s previous easing measures. That said, there’s also an argument for not overreacting to every market move, especially since yields are still near historic lows and have retreated a little lately.
If the ECB simply resorts to words, investors looking for action may be disappointed, resulting in a modest spike in yields that benefits the euro today. Even if the euro rebounds though, the bigger picture seems negative. Unlike the Eurozone, the US vaccination program is firing on all cylinders and the economy is likely to experience a massive stimulus-fueled boom that ultimately leads the Fed to normalize policy much earlier than the ECB.
Dow marches to a new record
In the broader market, serenity prevailed on Wednesday as a subdued US inflation print and a solid 10-year Treasury auction calmed global bond yields, propelling the Dow Jones to a new record high. Rising yields are generally negative for stock markets, so when yields stabilize or pull back like yesterday, equities breathe a sigh of relief.
Adding fuel to the cheerful mood was news that the US Congress gave final approval to the colossal $1.9 trillion spending bill and that President Biden will now turn his attention to an infrastructure investment package, which might be in the ballpark of $2.5 trillion. Make no mistake, this level of government support is unprecedented. It makes the New Deal look almost like child’s play in percentage of GDP terms.
This could be the new theme in markets. Even if the final figure is watered down as the negotiations unfold, there’s no question that throwing even more money at the problem is going to turbocharge the US economy, especially if that spending is directed at infrastructure that tends to generate a higher ‘multiplier effect’ and positive spillover effects.
This might be why value plays have been outperforming growth and tech stocks lately. If the underlying economy is doing well, paying exorbitant valuation premiums for tech stories is not as appealing anymore. Tech was essentially the only sector growing this past decade, but markets are saying this paradigm could change. The tech sector is also more vulnerable to higher yields.
Dollar lags, everything else smiles
In the FX spectrum, the main casualty of the retreat in yields and the calmer mood has been the dollar. In turn, a softer dollar serves as a boost for all other major currencies.
While the dollar could remain under pressure for now, especially if the ECB doesn’t take action today, the overall picture seems favorable against the euro and yen. All the federal spending and the millions of vaccinations per day are going to show up in economic data heading into the spring.
Gold has also capitalized on the softer dollar and lower yields, though the real test is whether bullion can cross back above $1765.
