Stocks had a mixed close yesterday as Treasury yields legged higher stalling gains in stocks in the wake of a weekend Congressional budget deal. Tech stocks defied rising yields by rallying because… they were oversold.
Passive AGGRESSIVE. I am going to show you an image and I want you to tell me what comes to mind. Check it out and let’s get on with your session.
Ok, it’s not some sort of Rorschach to test your hidden psychoses, but it most likely does stir up some hidden anger, if not anxiety in you. Well, what do you see when you look at the chart? It is not a trick question as I did take the liberty of adding a title in legible orange text. That’s right this is a chart of the yield to maturity of 10-year Treasury notes. As of this morning, 10-year Note yields are around 4.73%! The last time yields were there was the summer of 2007! And dare I remind you that those very yields were at 0.50% in 2020? The fact that yields are so high is bad enough, let alone how quickly yields got to these levels.
Take a look at the chart again and take notice of the high-level trend pattern. Since spiking in early 2007, yields, for the most part, trended lower and lower… and lower yet through the summer of 2020 to their all-time lows, and then it was a relentless moonshot straight up to where we are today. Between the 2007 high and the 2020 low, lots happened. Namely, The Global Financial Crisis, The Great Recession, the introduction of QE, ZIRP part 1 (ZIRP = zero interest rate policy), unwinding the balance sheet part 1, a mid-cycle rate adjustment (down), COVID, the pandemic flash recession, ZIRP part 2, and massive, “unprecedented” quantitative easing. That is quite a bit, isn’t it. One other thing which must be noted is that, throughout that period, inflation was, for the most part, on target. Come on, do you even remember hearing any discussion about inflation in the years prior to the pandemic? Of course, you don’t.
Obviously by now, we all know that inflation became a problem in 2021 resulting from massive stimulus and a broken supply chain. In economic terms that is a supply shock AND a demand shock. Both separate cause prices to rise, but together, cause prices to rise uncomfortably quickly. Old news by now. If inflation is expected to be higher, you would want more yield out of your bonds… you know, to cover that inflation. If your bonds are yielding 2% a year and inflation is 8%, your real yield is -6%, which means that you are technically losing money. That is likely to cause you to ditch your bonds. Selling bonds causes their price to go lower and yields to rise. Once yields get to attractive levels, folks will buy them once again. That is certainly the primary driver of the rise in yields in longer-maturity Treasuries. Shorter maturity yields have risen as well, but those are primarily tied to Fed policy. One last note on those longer-maturity yields and then back to the Fed. Even if bond traders believe that the economy will be booming in the years ahead, they will sell Treasuries in anticipation that the booming economy will come with inflation. Oh, and by the way, the vice versa occurs when traders expect economic turmoil. That’s right, bond yields come down and Treasuries rally. Of course, there are many factors that cause bond yields to fluctuate, but these are the primary ones.
The Fed is trying desperately to squelch inflation by stifling economic growth. Yeah… it’s a thing . The Fed is really, really trying, and though its efforts have had some success, inflation is far from normal still. That is precisely why it will simply not give up. It will not give up its option to raise rates further by announcing an end to the hikes. Further, it may still raise rates further if the trend of cooling inflation does not continue. But there is more. We spend lots of time talking about rate hikes and potential rate hikes, while we cannot ignore all the ambiguous Fed-speak which has us all nervous, if not confused about what might be next for rates. One thing that we don’t talk about too much is the Fed’s quantitative tightening, which involves selling bonds. That is happening, and its express goal is to take money out of the system, reduce its balance sheet, and CAUSE YIELDS TO CLIMB… because higher yields stifle economic growth… and, theoretically, cause inflation to ease. Now, the most recent spike in bond yields is not likely caused by the Fed’s bond selling, which means that bond traders are actually doing the bidding of the Fed. Surely the Fed is happy to sit back, passively, and watch those yields go higher as they cause havoc on bank balance sheets, the housing market, real estate investment, and the stock market. Unfortunately, the one area that those yields have not affected yet is consumer spending. It seems that the only way the Fed can affect that is through a good old-fashioned recession, and it seems that Fed members, a good number of them at least, have not ruled that out as a solution.
WHAT’S ON THE MOVE
McCormick & Co Inc (MKC) shares are lower by -3.00% in the premarket after the company announced that it missed EPS and Revenue estimates last quarter. The company raised its full-year EPS guidance by +$0.02 which is in line with estimates. The company attributes last quarter’s miss to a slower-than-expected recovery in China. Dividend yield: 2.08%. Potential average analyst target upside: +12.7%.
HP Inc (HPQ) shares are higher by +2.4% in the premarket after BofA double upgraded the stock from UNDERPERFORM to BUY and raised its price target to $33 from $25. BofA believes that cost cuts have stabilized margins, the PC market has bottomed out, and that the stock is oversold. The stock has experienced 7 straight weeks of negative returns and Berskshire Hathaway has been a seller (to the tune of some $540 million), which surely has not helped performance. Dividend yield: 4.08%. Potential average analyst target upside: +19.6%.
YESTERDAY’S MARKETS
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