Bond Market Turmoil and the S&P 500

Are interest rates on long term bonds rising because of expectations of post-Coronavirus Recession growth? Or are they rising because the specter of inflation is becoming a real problem?

The as yet unknown answers to these questions is having an effect on the U.S. stock market, because bond investors have hedged their bets on bond yields over the past year by buying up high-flying tech stocks. For them, rising interest rates on bonds means losses, which they can and have offset by selling their tech-heavy stock holdings.

That dynamic helps explain why the tech-heavy Nasdaq has born the brunt of recent drops in stock prices in recent weeks, where the S&P 500 (Index: SPX) has been affected because of where the index overlaps those stocks. As you can see in the latest update to the alternative futures chart, the S&P 500 has generally risen along with the stocks that will benefit most from a post-Coronavirus Recession recovery.

The Federal Reserve, for its part, announced on Wednesday, 17 March 2021 that it would keep the short-term interest rates it controls at or near the zero level, indicating they are willing to allow inflation room to rise. On paper, setting that expectation should boost tech stocks, which is what happened after the Fed’s meeting.

But the Fed isn’t the only institution whose policies affect interest rates. On Friday, actions by the U.S. Treasury Department contributed to an environment where short term interest rates for U.S. Treasuries dropped below 0% and became negative, as President Biden’s “stimulus” spending starts to get underway, dramatically increasing the amount of money the U.S. government borrows. The Fed’s minions signaled they were comfortable with allowing interest rates become negative, which is a change from the expectations they had previously set.

The sudden arrival of negative short term interest rates and rising long term interest rates spells turmoil for the bond market, which will affect the stock market.

Meanwhile, other stuff happened during the week with market-moving potential. Here’s our summary of the headlines for those stories:

Monday, 15 March 2021

• Signs and portents for the U.S. economy:

• Big questions loom ahead of Biden’s next spending push, like ‘what is infrastructure?’
• Oil slips, retreats from gains notched on strong Chinese data

Fed minions not expected to shift monetary policy:

• Fed likely to pen rosier forecasts, but no policy shift expected

Bigger inflation developing in Brazil, bigger stimulus developing in Eurozone:

• Brazil to raise rates 50 bps as inflation mounts, first hike since 2015: Reuters poll
• Euro zone ministers pledge to extend fiscal support through 2022

China economy shows rebound:

• China mills crank up Jan-Feb crude steel output by 13% on firm demand outlook
• China’s Jan-Feb refinery output up 15% on solid demand for fuels

BOJ minions want to stop buying so many risky assets, ECB minions buying bonds:

• In turning point for Kuroda, BOJ may phase out asset-buying goal
• ECB ups bond buys to cap rise in yields

• Exclusive: ECB expects data to vindicate 1.85 trillion euro purchasing scheme: policymaker

S&P 500 and Dow end session at record highs

Tuesday, 16 March 2021

• Signs and portents for the U.S. economy:

• U.S. import prices rise strongly in February, boosted by crude oil, commodities
• Oil drops as COVID-19 vaccine halt [in Eurozone] threatens demand

• Oil demand drag takes toll on tankers, U.S. refiners

Winter storms hammer U.S. manufacturing production

U.S. business inventories rise moderately in January as sales surge

U.S. companies issue more fixed-rate debt as yields rise

Anxious Americans to pay debt, taxes with COVID-19 stimulus checks

Fed minions not expected to shift monetary policy:

• Fed officials may talk technical rate move but delay acting for now
• ‘Taper tantrum’ worries creeping in, but equity crash not imminent: BofA

Bigger trouble developing in Eurozone:

• EU system needed for dealing with failing insurers, EU official saysz
• Germany’s AstraZeneca move could stymie recovery, economists say
• France has spent more to help virus-hit companies than Germany: EU data
• Euro zone bank not watching souring credit well enough: ECB

BOJ , ECB minions want ‘stably low’ yield curves

• BOJ’s Kuroda stresses need to keep yield curve ‘stably low’
• ECB wants to keep yields in check while economy heals, Lane tells FT

S&P 500 ends lower as investors eye Fed meeting

Wednesday, 17 March 2021

• Signs and portents for the U.S. economy:

• Travel on U.S. roads fell 11.3% in January over 2020 levels
• U.S. weekly jobless claims increase; mid-Atlantic factory activity near 50-year high
• Oil hits skids, drops 7% on worsening outlook for coronavirus in Europe
• U.S. bond worries remain after dovish Fed meeting

• Analysis: U.S. bond market feels like ‘coiled spring’ after Fed meeting
• Analysis: Fed move eases pressure on money funds, but more may be needed
• U.S. yields hit new heights; oil skids amid COVID-19 fears in Europe

Fed minions optimistic for U.S. growth, will hold rates near 0% despite rising inflation, punt on updating bank liquidity rules:

• Analysis: Fed’s Powell faces political test on bank capital relief issue

Bigger trouble developing in Eurozone, Canada:

• Paris goes into lockdown as COVID-19 variant rampages
• AstraZeneca covid vaccine suspended even as third wave hits Europe
• Canada sheds jobs for second straight month in February: ADP

BOJ minions dropping ETF buys to adopt more flexible rates; ECB minions prioritize climate change over COVID recovery, but act to bail out banks:

• BOJ to widen band around long-term rate target on Friday: Nikkei
• ECB stress testing broader economy over climate risk: de Guindos
• ECB’s Lagarde warns stimulus may take some time to show up
• ECB welcomes Greece’s plan to extend Hercules bad-loan reduction scheme

Wall Street ends sharply lower, hit by bond yields and COVID-19 worries

Thursday, 18 March 2021

• Signs and portents for the U.S. economy:

• U.S. travel spending sank 42% in 2020 due to pandemic: industry group
• U.S. homebuilding takes a step back amid bitterly cold weather
• Oil falls further on demand outlook, U.S. stock build

Fed minions optimistic for U.S. growth, will hold rates near 0% despite rising inflation, punt on updating bank liquidity rules:

• FOMC: Accelerated growth seen, only slight change in tightening outlook
• Fed expects growth surge, inflation jump in 2021 but no rate hike
• Fed’s Powell: U.S.-driven global recovery could help lift laggards like Europe
• Powell says Fed will announce update on SLR exemption in coming days

Bigger trouble developing in Eurozone:

• German economy to shrink by 2% in first quarter: government advisers
• Facing ‘crisis of century’, EU threatens ban on COVID vaccine exports to UK

Wall Street ends sharply lower, hit by bond yields and COVID-19 worries

Friday, 19 March 2021

• Daily signs and portents for the U.S. economy:

• Oil prices rise 2% but post weekly decline on demand fears

Fed minions tighten monetary policy, say optimism and not rising inflation expectations behind rising rates, plead guilty to a data heist:

• U.S. Fed to let bank-leverage exemption expire this month, will review rule
• Rise in bond yields reflects economic optimism: Fed’s Barkin

• Bond managers say pace of rise in U.S. bond yields ‘unsettling’
• Explainer: What rising bond yields mean for markets
• U.S. 10-year yield could rise to 2.15% by year-end: BofA

Former U.S. Fed employee pleads guilty to stealing bank stress test data

Bigger inflation developing in Russia, bigger debt-funded stimulus in Eurozone:

• Russia lifts interest rates amid rising inflation, geopolitical risks
• Germany pushes up record debt plans to more than 240 billion euros: sources

BOJ minions to let bond interest rates float more:

• BOJ widens yield band, pledges to buy risky assets only when necessary
• BOJ Governor Kuroda’s comments at news conference

ECB minions to drag out digital currency development:

• Digital euro may still be five years away, ECB’s Panetta says

Wall Street ends mixed as Treasury yields pause

Did we catch all the news that mattered to the market? If you are looking for another view of the news of the week that was, check out Barry Ritholtz’ list of positives and negatives he found in the past week’s markets and economics news.