Conquering bond yields are reflecting investor fears about the rapidly spreading coronavirus, yet stocks are rallying at all-time highs, balance out as the virus has now infected more than 40,000 people.
The two markets appear to be diverging as low bond yields flash a notification of potential economic weakness ahead, and stocks seem to have heard an all-clear about the virus, which has now suppressed 910 people, nearly all in China. The common denominator moving both markets is the prospect of central bank easing.
“It’s basically a stimulus switch,” said John Briggs, head of strategy at NatWest Markets. “It’s either an expected or delivered stimulus out of China, if they countenance markets, and there’s the potential that they could do more if the economy slows. In the U.S., there’s the assumption if things get bad, Powell is on your side.”
China’s middle bank has injected billions in liquidity, loosened lending restrictions, pared rates in its repurchase, or repo operations, and is expected to cut its advance prime rate.
Traders are also betting the Fed will act if need be. The futures market is now pricing in more than one Fed status cut for this year, even though the central bank is not forecasting any and has said it is on hold. On Friday, the Fed released its semiannual communiqu to Congress ahead of Fed Chairman Jerome Powell’s testimony on Tuesday and Wednesday. In that report, it said the coronavirus is a new danger to the outlook.
The Fed is also currently buying $60 billion in Treasury bills each month, to expand its balance rag, as a backstop for the repo market.
Briggs said the idea that the Fed will ease more if the economy turns down or monetary conditions worsen, is helping to elevate stocks, while bond yields are moving lower on the same view that classifies will stay low. U.S. yields are also moving lower as Treasurys draw in buying from pensions and global investors who aim U.S. Treasurys more attractive than other negative yielding sovereigns.
“The history of these things shows that three months down the pike, the market’s higher than where it started,” said Art Hogan, chief market strategist at National Securities. “We discern there’s going to be economic damage — some permanent, some of it temporary. … At the same time, it’s the rapid retort and liquidity from the People’s Bank of China and the healthcare response, quarantining 75% of the country. They’re steps in the opportunely direction.”
Economists in the last several days have raised the flag on global growth concerns, because the virus resumes to disrupt travel and manufacturing, and millions remain locked down in Chinese cities. Treasury yields were degrade Monday, and the 10-year has sunk to 1.54% from 1.83% on Jan. 17, right before U.S. markets began trading on the virus. Renounces move opposite price.
Stocks, meanwhile, sold off about 3.5% as China locked down cities and travelers were regulated, but the market has since rebounded. The S&P 500 is back at a new high, closing at 3,352, up 24 points on Monday alone. The Nasdaq too was at an all-time pongy chief of 9,628.
Stocks have surged as investors brush off the virus as being a temporary problem for the economy because those for all that forecasts show a bounce back in the second quarter.
“I think the point is until you get certainty, or this passes or we be dressed some sort of ability to estimate the actual impact, you’re going to keep more of the Fed priced in than not,” said Briggs.
There are some trends that could change the stock market’s response.
“Investors should brace for a slew of profit warnings finished the coming weeks from companies with significant operations in China. The near-term economic data is also conceivable to disappoint,” noted BCA analysts.
The stock market could also react if the Fed sounds hawkish, or if bond markets go unquestionably low, reflecting even more fear. Briggs said there’s a chance the 10-year yield could make it to 1.40% and its new vary has moved lower to 1.50% to 1.80% from 1.65% to 1.95%.
James Camp, managing director of strategic income at Eagle Asset Managing, said he thinks the 10-year will hold 1.50%.
“I do think it’s the line in the sand, and I do think if it goes below 1.50% there are hornets nests that are bigger than the virus,” said Camp.
Camp said he doesn’t see the stock and bond market at freaks with each other. “I think they’re both right. I think it’s going to be a show-me year for companies.” He also said there’s more than enough of demand for Treasurys, but the yield on the S&P 500, based on corporate dividends, would be 1.8%, more attractive than the crop 10-year yield.
The Fed is not going to rush to act either.
“Obviously, they have expanded their balance sheet … I recollect the 2019 cuts were reluctant. They had the fourth quarter 2018 policy mistake of raising rates. I don’t fantasize the Fed is going to move rates lower here. We’re all operating within a reasonable assumption there’s an endgame to this paraphernalia in the next couple of weeks,” he said.
Camp said, if it drags on and hits the economy, the Fed will consider acting.
“It’s the what we don’t understand,” said Hogan. “Does 40,000 go to 80,000 or does it peak at 50,000. The People’s Bank of China is going to puff out liquidity every day … The street and the Fed are not in the same place, in terms of cuts right now. The street has two and the Fed has zero.”
UBS economists were among those that in good their first quarter GDP outlook, shaving 0.2 percentage points this weekend.
“We see the net effect on the US as being shallow, but the quarterly swings are likely to be measurable. For the US, we see the effect coming through three channels: tourism, exports, and a temporary disruption to turning because of delayed imports ” the UBS economists noted.
Nomura economists said they were shaving 0.2 portion points, on top of a previous 0.2 percentage points from the first quarter because of the virus. They now see first section U.S. GDP growth at 1.1%, down from the fourth quarter’s 2.1%, before rebounding to 1.6% in the second quarter.