The rise in global bond yields, fuelled by rising interest rates, has become one of the central themes affecting stock markets. This week’s Jackson Hole Symposium sets the stage for bond market action for the rest of 2022.
During a difficult period as the world grapples with the Russia-Ukraine war and the residual impact of two years of lockdown, rising interest rates have in many ways added to the difficulties faced by domestic economies and the global economy alike.
However, the drive behind the need for higher rates this year has been the surge in inflation we have seen across the board. The factors mentioned above have contributed to a stark rise in consumer prices around the globe, exacerbated by the record spike in energy prices we’ve seen this year.
Despite concerns over the impact on growth, many central banks within the G10 and elsewhere have been undergoing aggressive tightening programs in a bid to quell the spike in inflation.
Equities and bonds alike have suffered sharply over Q2 and into Q3 as bond yields continue to rise.
However, with bond yields now sitting off their yearly highs and most equities indices having made a decent recovery, traders are now questioning whether rates are likely to continue moving higher.
To establish a view on this, let’s first unpack what’s been driving these markets recently and how those factors look set to develop or shift over the rest of the year.
Issues Driving Yields & Stocks This Year
- Fed monetary tightening
- “Fed pivot”
Fed Rate Hike Expectations
The driving force behind the movement we’re seeing in bond yields and stock markets is the Fed and market expectations with regards to its tightening program. The Fed caught markets somewhat off-guard with how aggressively hawkish it turned following the March FOMC earlier this year. After the initial quarter-point hike, the Fed’s guidance became increasingly pointed towards faster and bigger action, leading to four months of larger hikes and more hawkish guidance.
This period saw the US Dollar advancing rapidly as the divergence between the Fed and many other central banks created demand for the USD. Similarly, stocks were seen falling as higher rates weighed on demand and investor sentiment.
More recently, we saw an interesting dynamic develop. Despite the Fed pushing ahead with rate hikes and maintaining a hawkish outlook in its guidance, there was a growing discussion around a potential Fed pivot.
The crux of this argument was that, with inflation expected to moderate into year-end and growth likely to suffer as a result of higher rates, the Fed would be forced to slow the pace of its tightening, likely ahead of schedule. This view caused a shift in market movement with share prices seen recovering ground over July and early August as bond yields fell back.
A Return to Fed Tightening Expectations
More recently markets returned to the themes which dominated Q2. The July FOMC minutes saw the Fed focusing itself on the task of defeating inflation. While the Fed was clear on the downside risks, it noted the need to keep tightening until inflation is brought back to target.
Some tried to argue that the minutes were outdated given the negative Q2 GDP print and softer July CPI reading we’d seen since that meeting. However, a raft of comments from a handful of Fed members last week voicing their support for continued tightening and sticking with higher rate increases has seen the idea of a Fed-pivot losing traction, sending stocks falling again as bond yields rise.
Outlook For Rest of Year
Upside Risks for Bond Yields
Looking across the remainder of the year, the outlook for bond yields and equities is very clearly linked to one thing: inflation. If inflation remains elevated, the Fed has outlined its plans to keep pushing ahead with rate hikes, despite the impact on growth. In this scenario, stocks likely continue falling and bond yields continue to rise.
Downside Risks for Bond Yields
On the other hand, if inflation starts coming off, this will turn focus back to the idea of a Fed-pivot, allowing stocks to rise as bond yields come off. With the July CPI having already moderated, a further weak print for August will add weight to the view that a top is already in for consumer prices, meaning that from October the Fed might have some room to dial back its tightening.
Jackson Hole on Watch
Given the split view in the market currently regarding the inflation outlook and the Fed rates outlook, the Jackson Hole Symposium presents an important opportunity to gain a clear insight into how the Fed sees the next few months playing out.
On the back of a severely wrong call last year (inflation spike to be transitory), there is a lot of pressure on Powell to get this assessment right. As such, we can expect plenty of market volatility on the back of Powell’s comments.
In light of the latest minutes and what we’ve heard recently, the base case scenario is for Powell to again reaffirm the bank’s commitment to battling inflation while acknowledging downside risks in the economy.
S&P 500 (candles) & US10 Year Yield (blue line)
Source: FlowBank / TradingView
The chart above shows the S&P 500 on the weekly timeframe with the US 10-year yield plotted as an overlay. You can see that from the start of the year, stocks have been trailing off and bond yields have been rising. Currently, the S&P is testing the bearish trend line from YTD highs, while bond yields look ready to break out higher once again. If the trend line holds in the S&P, supported by a break out in yields, the outlook remains bearish in the coming months.