Markets Adjusting for a New Growth Trajectory
U.S. stocks continued to record new highs in June on the heels of better-than-expected employment data and rebounding consumer confidence. This is despite continued frictions in the labor market and supply chain bottlenecks. The most notable development however has been the decline in yields, with the 10-Year U.S. Treasury falling to 1.30% from its recent high of 1.74%. Many are pinning the move on technical factors, that the move in bonds has caught many participants offside prompting a capitulatory short covering rally. Others are suggesting a range of factors from a stalling economic recovery, tensions with China regarding Taiwan, and oil markets in flux with OPEC+ in disarray. Whatever the reason, it warrants attention as both the direction and velocity of further rate moves will have significant ramifications across all asset classes.
In credit markets, the post-pandemic trends remain intact. Spreads on investment-grade and high-yield bonds narrowed to the lowest levels since 2005 and 2007 respectively. Issuance remains on a record pace with Bank of America calling for high-yield issuance to hit $500 billion this year.
Another meaningful market catalyst was the OPEC+ negotiations that fell apart on Monday. The crux of the problem is the UAE’s opposition to a Saudi-led production deal that would extend quota limits. The UAE wants to re-negotiate the level from which its output is calculated so it can produce more crude. How the issue plays out at OPEC+ is relevant for energy supplies as major economies reopen. But the effects of the UAE-Saudi spat also has political repercussions in the
Middle East. The kneejerk reaction to the negotiations failing sent crude oil higher but that has since reversed course. The reversal could in part be attributed to U.S. shale producers picking up the slack as demand continues to be robust, but it could also be another sign that the recovery trade is faltering. Since the beginning of June, the yield curve has flattened and bond yields have dropped, implying that investors forecast lower inflation and a less powerful economy that won’t need higher rates to slow it down. OPEC+ is aware of the productive capacity of U.S. shale, and it is widely expected that they will come to an eventual resolution that adds overall supply to the market.
Earnings season kicks off in earnest next week with several large banks reporting. Consensus earnings expectations are calling for 61% YoY. As always markets will be keenly focused on company guidance. We continue to remain constructive on equities for 2H21 but with the VIX Index currently back down to pre-pandemic levels, we expect more volatility in the new quarter.
Ryan Babeuf, CFA
Market Strategist
Ryan.Babeuf@EdgeWealth.com
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