Return of the Bond Traders, if not the Vigilantes

A few days a year, I’m envious of bond traders.  It’s not that I find their lives inherently more interesting, it’s that they get more holidays than those of us who focus on equities.  One of them was yesterday, when they were closed for Veterans Day.[i]  Now that they’ve returned, they appear to have an unpleasant message for markets.
 
One of the “Trump trades” involved expectations of higher yields.  Bond investors are understandably nervous about the potential budgetary and inflationary implications of tariffs and deportations.  Either has the potential to raise prices and/or cost money depending upon whether and how they are implemented.  We saw yields shoot higher last week as traders processed the incoming election returns, but then saw them recover most of their losses over the remainder of the week.  A solid 30-year auction and a generally benign FOMC meeting certainly helped calm bonds’ jitters. 
 
Unfortunately, after yesterday’s hiatus, those jitters returned today.  We now have 2-year yields at 4.32%, above their post-election worst and about 15 basis points above their pre-election level.  10-year yields are higher by a similar amount, though at 4.41% they have not topped Wednesday’s 4.47% peak. 

6-Day Line Chart, 2-Year Treasury Yields (white), 10-Year Treasury Yields (blue)

Source: Bloomberg
 
We see the Treasury yield curve with a generally parallel shift higher for notes with longer than 1 year to maturity.

US Treasury Yield Curve, Today (green), 1 Week Ago (yellow)

Source: Bloomberg
 
Higher yields are also affecting currency markets.  Higher US yields tend to make the dollar more attractive against foreign currencies, and we see the greenback at multi-month, or longer, highs against the Euro, Yen, Canadian dollar, and more.   Gold, which often acts like an “anti-dollar” continues to fade from recent highs amidst dollar strength.  (Though it could of be suffering as traders pile into cryptocurrencies instead).

Spot Gold, 6-Months, Daily Candles (top), with MACD (12,26,9, bottom)

Source: Interactive Brokers
 
Although stocks have succumbed to some profit-taking this morning, we can’t necessarily blame it on the bond market today.  Higher yields certainly aren’t helpful for stocks but remember that stocks had essentially sideways moves for the prior two sessions.  It is not unusual for stocks to have difficulty piercing major psychological levels, like 6,000 for the S&P 500, nor is it odd that we might see some consolidation or profit-taking after last week’s sharp advance. 
 
But over time, higher yields and a stronger dollar are not conducive to higher stock prices.  When fundamental valuations matter – and it’s not clear to me that they do matter to many investors right now – higher rates decrease the present value of a company’s future earnings and cash flows.  That should reduce the amount that investors are willing to pay.  Furthermore, a stronger dollar is not helpful for US multinational companies because it reduces the value of any sales made in foreign currencies.  This becomes a question of timing, though.  It might matter today, tomorrow, weeks from now, or seemingly never.  The better the market psychology, the longer that stocks can withstand higher yields.  And market psychology is undoubtedly quite robust.
 
With one day back from a long weekend and only a week since the election, it is far too soon to say whether the so-called “bond vigilantes” are the ones pushing rates higher.  But they bear watching (no pun intended, maybe).  If enough investors, domestic or foreign, become sufficiently concerned about the path of fiscal policy in the incoming administration, that could provide a headwind which might offset the gusty tailwind that pushed stocks higher after the election.

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[i] Bonds were also closed for Columbus Day on October 14^th.  And it’s even more infuriating when they close early ahead of long weekends, such as 2pm on the Friday before Memorial Day.  Goodness knows, bond traders can’t be required to sit in traffic like the rest of us working stiffs.  The only small consolation is that on half-days, such as the Friday after Thanksgiving, bonds are open for one hour longer than stocks.