Wall St Week Ahead: Declining Bond Yields Bolster Equities Allure Ahead of Fed Meeting

NEW YORK, March 17 (Reuters) – US equities have gained an unexpected ally in recent days: a historic fall in bond yields.

U.S. Treasury yields fell sharply this week, with some maturities marking the biggest declines in decades, as investors bet the Federal Reserve is likely to curb its aggressive rate hike to prevent the stress in the financial system following the Silicon Valley bankruptcies. Bank and Signature Bank worsens.

Volatility in fixed income markets has upset investors, and falling yields may reflect expectations that the Fed will cut rates as a blow to growth.

At the same time, the decline in yields has so far been a boon for equities, especially technology and other big growth stocks whose relatively strong performance helped support the benchmark S&P 500 (.SPX). The index ended the week up 1.4%, with strong technology stocks outweighing sharp declines in banking stocks.

While the banking crisis has fueled fears of a recession, “it’s interest rate movements that are currently a tailwind for equities,” said Charlie McElligott, general manager of cross-asset macro strategy at Nomura.

Technology stocks versus US bond yields

The near-term trajectory of interest rates will likely depend on next week’s Federal Reserve meeting. Signs that the central bank may be prioritizing financial stability and slowing or pausing its rate hikes could push interest rates even lower. Conversely, yields could recover if the Fed signals that reducing inflation – which remains high despite a barrage of rate hikes – will remain job one.

“The market is not quite sure how the Fed is going to view this,” said Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions.

For now, futures markets indicate that investors are assigning a 60% probability of a 25 basis point rate hike at the March 21-22 Fed meeting, with rate cuts to follow later in the year – a sharp reversal from the aggressive expectations that prevailed earlier this month.

“For the first time in this Fed’s tightening cycle, the Fed must now strike a balance between its inflation-fighting credibility and financial market stability,” said Michael Arone, chief investment strategist at State Street Global Advisors.

Treasury yields fell to all-time lows after the Fed cut rates to support the economy at the start of the COVID-19 pandemic, sparking a stock market rally with the S&P 500 at one point doubling from its March lows 2020.

When the Fed began tightening monetary policy to fight inflation a year ago, government bond yields began to rise, providing investors with an increasingly attractive alternative to equities. The two-year rate, recently at 3.85%, hit a 15-year high of 5.08% earlier this month.

According to some statistics, the recent fall in prices has helped make stocks attractive again. The equity risk premium, or the extra return investors expect to receive for holding equities rather than risk-free government bonds, has recovered to levels seen in early January, but still remains near the lowest level in the world, according to data from Refinitiv. more than ten years.

Other statistics show that stocks remain expensive by historical standards. According to Refinitiv Datastream, the S&P 500 trades at 17.5 times forward earnings compared to its historical average P/E of 15.6 times.

Valuation of the US stock market

The rally in interest-rate areas such as technology stocks suggests that the market expects rates to continue falling as a widely feared recession approaches, Nomura’s McElligott said.

The S&P 500 information technology sector (.SPLRCT) and communications services sector (.SPLRCL) rose more than 5% and nearly 7%, respectively, this week, supported by strong gains in megacap stocks Microsoft Corp. (MSFT.O) and Google parent Alphabet Inc (GOOGL.O).

However, some investors are skeptical about equity valuations. Bob Kalman, senior portfolio manager at Miramar Capital, said the Nasdaq 100 (.NDX) should be trading at no more than 25 times future earnings given current interest rates, below the current 27.3.

“People have this muscle memory to buy mega-cap technology when they get nervous,” Kalman said. “But the Fed hasn’t backtracked on its rhetoric that they know they have to fire because inflation is a much bigger concern in the economy than a few bank failures.”

Reporting by Lewis Krauskopf and David Randall; Edited by Ira Iosebashvili and Richard Chang

Our Standards: The Thomson Reuters Principles of Trust.


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