Real yields turn positive ahead of Fed, boosting dollar but bruising gold
Stock markets stage comeback, battered tech shares lead the charge
RBA raises interest rates, aussie jumps despite Chinese slowdown
Real yields matter
The Fed’s wish to tighten financial conditions has come true just in time for tomorrow’s policy meeting. In a sharp move, ten-year US real yields clawed their way into positive territory yesterday, resurrecting bonds as an asset class and dealing a devastating blow to the long-standing argument that there is no alternative to stocks.
Real yields are the true cost of borrowing once inflation has been accounted for, so they have tremendous implications for businesses, policymakers, and financial markets. When real yields are negative, bonds are essentially a dead asset class that’s guaranteed to lose you money, which ultimately pushes investors to take bigger risks in the stock market.
But when real yields are positive and rising, bonds turn into a viable investment again, cooling the speculative euphoria in equities. This force is similar to gravity for financial markets - the higher real yields go, the harder it becomes for riskier assets to gain ground.
The good news is that traders are betting the Fed will manage to put the inflation genie back into the bottle. Real yields are rising because inflation expectations are falling, which means the Fed has finally started to regain control over the narrative. It doesn’t need to deploy as much firepower to get the job done.
Dollar shines, gold slides
All this is music to the ears of US dollar bulls. Higher real US yields compared to those in the rest of the world imply more capital inflows into American markets and therefore persistent demand for the greenback. The dollar has already demolished everything in its path amid a perfect storm of rising US rates, safe haven demand, and storm clouds gathering over Europe and China.
The FOMC decision tomorrow will be critical, and it won’t be easy for Powell and his colleagues to outgun market expectations. The bar has been set quite high with half percentage-point rate increases already fully priced in at each of the next four meetings.
Crossing into the commodity sphere, gold bulls are being carried out in a stretcher. The cumulative weight of positive real yields and a fired-up dollar has proven too much for the yellow metal, which cracked below the $1860 region. The silver lining is that the drop hasn’t been dramatic considering the seismic moves in yields, with gold being one of the few assets that’s still trading higher for the year thanks to geopolitical stress.
RBA raises rates, Wall Street comeback
Over in Australia, the Reserve Bank raised rates by 25 basis points, pushing the Australian dollar higher as the hike was bigger than what economists predicted. However, the outlook seems negative. Markets are pricing in another 11 rate hikes for this year - it will be a miracle if the RBA can deliver anything close to that with the Chinese economy losing power.
Equity markets had a wild session too. It started with a flash crash in European stocks after a ‘fat finger’ trade from Citigroup and the sour mood carried over into Wall Street. The bulls were on the ropes until the final hour of trading, when a massive comeback in tech shares pushed the entire market higher.
Volatility has become embedded as markets keep getting hit with one shock after another while liquidity gets withdrawn. Fiscal and monetary policy are tightening simultaneously, consumers are struggling with higher living costs that haven't been matched by higher wages, and the outlook for global growth is deteriorating with Europe and China in deep trouble.
On the bright side, there is optimism that inflation might cool towards the end of the year, allowing the Fed to take its foot off the brakes, especially if recessionary worries intensify or if China loosens its strict covid rules. The earnings season will continue with AMD, Pfizer, and Starbucks releasing their quarterly results today.