October 31, 2023
Today’s dip in longer-dated bond yields follows a relatively benign BOJ policy outcome. The BOJ increased its inflation forecasts as expected, but said its 1% ceiling on 10-year JGB yields will now be a ‘reference point’ rather than raising it as some reports suggested. Longer-dated bonds also have a bid after China PMIs missed and headline Eurozone CPI for October undershot consensus, falling to 2.9% from 4.3% in September. This is the first time Eurozone inflation has been below 3% since mid-2021. Also, note that Europe’s earnings season is now showing negative EPS growth and a record number of revenue misses. Meanwhile, US data keeps upward pressure on short-term yields following a hot Q3 Employment Cost Index, higher inflation expectations in the October Conference Board index and firmer August home prices.
The -10% correction in the SPX and NDX has resulted in oversold conditions that can provide some fuel for a relief rally. In the current environment, 10-year yields moving below 4.73% would be the likely trigger of a 3-5% relief rally in the SPX, while a sustained move below 4.48% could drive a more meaningful recovery of 7-10%.
The US Economic Surprise Index (ESI) moved above its 50 and 100-day moving average last Thursday. When this happened in early June, it resulted in the SPX trading through key resistance levels at 4200. The improved ESI from June backfilled the soft landing narrative and provided equity upside until 10-year yields moved to a cycle high above 4.20%.
Bonds and equities have been positively correlated since the Fed’s hiking cycle began in early ’22, but the move to a new cycle high above 4.20% in August resulted in a much stronger correlation. At this point, we don’t see 10-year yields moving below 4.48% unless there’s a break in bond-equity correlation. This would mean that lower yields can only be achieved if growth concerns rise and stock prices fall.
Q3 productivity data will be released this Thursday. Higher levels of productivity push down unit labor costs, and a strong Q3 number has the potential to temporarily reinstate the soft landing narrative.