Investors load up on riskier assets, dump safe havens as new year begins
US stocks hit new records, dollar follows yields higher, yen gets hammered
OPEC meeting and ISM manufacturing survey coming up today
Funds position for new year
A sense of optimism dominated on the first trading day of the year. Money managers loaded up their books with riskier assets such as equities and dumped defensive plays like bonds, positioning themselves for another stellar year in financial markets.
With the Fed scheduled to stop asset purchases this quarter and raise interest rates three times this year, there’s a clear risk that Treasury yields could storm higher. This would imply losses for many bond holders, so fund managers have started front-running this move by unloading their bonds.
There is also relief that Omicron won’t be quite as bad as previous variants despite the explosion in new cases, fueling the appetite for risk even further. Even though hospitalization rates in most countries have started to creep up, they remain below previous peaks and the political willpower for lockdowns has been depleted.
The result was a sharp rally in yields that put the wind back into the dollar’s sails. Dollar/yen hit a new 5-year high in the aftermath as traders cut their exposure to haven assets and rate differentials widened against the yen, courtesy of the Bank of Japan’s strategy that keeps a ceiling on Japanese yields.
Stocks power to new records
It was a similar story in the stock market where the S&P 500 closed at a new record high. The heavy lifting was done by Tesla, which gained a stunning 13.5% after reporting car deliveries that far exceeded expectations on Wall Street.
Of course, the real story for equities in recent years has been the overload of liquidity from central banks. Even though the Fed is slowly taking its foot off the accelerator, the financial system is still overflowing in excess liquidity and all that cash needs a home. If you can’t hold bonds because returns are horrible and higher yields could hurt your portfolio, the only other avenue is equities.
Therefore, stocks are still the only game in town and a few cautious Fed rate hikes are unlikely to change that. Higher rates may allow for a regime of greater volatility but for monetary policy to truly hurt markets, it may require a shrinking of the Fed’s balance sheet through ‘quantitative tightening’ like in 2018, which is not on the table for now.
Gold gets hit, OPEC in focus
In the commodity sphere, the simultaneous rally in Treasury yields and the dollar dealt a severe blow to gold. Bullion is priced in dollars and offers no yield to hold, making it less attractive by comparison as yields move higher.
Overall, the outlook for the yellow metal seems precarious. Ever since the pandemic hit, ‘real yields’ have been what matters most for gold. Real yields hit record low after record low last year, and yet bullion was unable to capitalize. If gold couldn’t rally in such a favorable environment, it could take heavy fire if real yields move higher this year as monetary policy normalizes.
As for today, oil traders will keep a close eye on OPEC+, which is widely expected to stick to its planned production increases. If so, the market reaction could be minimal, with oil prices taking their cues from risk appetite instead. Finally, the latest ISM manufacturing print will shed some light on how the US economy closed the year.