Eerie calm as yields race higher

Summary

Stock markets are a little like rabbits in headlights, as benchmark yields approach levels that have, historically, been cause for concern.

Nothing to see here

One of the most eye-catching points about the mid-week global yield acceleration is the level of relative cross-asset calm that accompanies it. Aside from cratering sovereign paper, pretty much across the curve, a patchwork of red and green across equity indices could be germane to dozens of global stock market sessions over the last few weeks. North American shares swing lower in caution after Wednesday’s advance. (Admittedly, Nasdaq contracts, ever sensitive, project a hefty slide when ‘cash’ opens). But in Europe, relief cooked-up in Italy has only slightly faded. Or it’s being reassessed as governmental intrigues—and the EU’s possible reaction—continue. 5-Star leader Di Maio denies a cabinet shuffle is in the works; the EU dismisses a report that it drafted a letter rejecting Italy’s provocative budget. So long as the benchmark BTP/bund yield spread keeps ticking lower—it was at 281.9 basis points just now after 300bp earlier this week—risk seekers will take either interpretation, as aversion will be contained. Furthermore, the rally in yields of less-troubled economies is another much-needed prop for Italian bank shares, as it is for lenders everywhere. Looking more broadly, fast-money plays on crude oil supply ahead of Iran sanction resumption on 4^th November, is back in play. There were higher lows in each two-hour interval since the early hours in Europe. In other words, Brent may be mounting a challenge on Wednesday’s new four-year high, though WTI/Brent were slightly off at last look.

Reasons to be less relaxed

That’s more underpinning for stocks, and another reason for participants to look through crazy 10-year yield optics with slightly rose-tinted spectacles. It’s tempting, perhaps even reasonable, to dismiss the recent mini crisis in weak current account FX as a flash in the pan. Still, dollar financing pain will be around for years, rather than weeks, and there are signs from currency basis-swaps that discomfort is beginning to be compounded by a new ‘dollar shortage’. Fractious trade politics have also paused rather than passed. The dispute seems to spread to new fronts, like possibly unintended South China Sea transgressions. There are also further indirect sanctions—see new ZTE penalties and NAFTA clauses aimed at chilling deal making between China and non-U.S. members.

When, not if

There’s a lot going on. Or rather, key watchpoints are at a higher level of intensity than earlier in the year. In February, amid relatively calmer conditions in geopolitics that can move markets, we saw a far deeper level of complacency shattered in a matter of days after the sudden realisation that positioning was on the exposed side of inflation risks. To be sure, much of those worries earlier in the year that global growth could see a hurried deceleration now look to exaggerated. And the U.S. economy remains comfortably on cruise control. Even so, it appears to be a matter of when, rather than if investors beat a sharper and more volatile retreat than seen in recent months.

Factory orders worth watching

There’s a welcome pause the most pivotal economic releases, with U.S. factory orders and Canada’s Ivey PMI at 15.00 BST as the items of broadest interest. Polls indicate a jump back into a the positive of 2.1% for August after the 0.8% retreat in the month before. As we have seen from this week’s ISM series, and even ADP’s typically lower-standard private payrolls take, forecasters are trending on the wrong side of data outcomes at the moment. A big enough rise above expectations should trigger input inflation and hence growth rethinks, consequently Treasury yields could get more fuel even before Friday’s NFP bonanza. The Ivey PMI is slightly less pertinent in a week like this. It did however, bounce sharply from July’s 5-month low last time. Further strengthening of business confidence—eyeing a NAFTA reformulation that’s better than its extinction—would be a good base for the Canadian dollar to punch back to Monday’s 5-month highs.