Morning Notes — Flash PMIs Tomorrow

Disintermediation: While the conditions that caused the 2003/2013 yield spikes don’t seem to exist at the moment, it’s also important to recognize the possibility of threats from other sources. The ‘negative convexity’ (durations rise as yields rise) of mortgages keeps this asset class at the top of our watch list. Commercial banks are currently short an estimated ~$1.5T of average 10-year duration assets, so they’d welcome higher yields.  Publicly traded mortgage originators are new to the scene and winning a lot of mortgage business over the banks.  These companies are not active duration hedgers at the moment (with one possible exception), but we’re keep a close eye on the share prices of these companies.  

Rotation: For equity investors, the current risk of higher bond yields is sector rotation.  Consumer Staples have been a source of funds for Financials since the 5-year/30-year Treasury yield spread broke through resistance at ~130bps.  High multiple Tech stocks began to rerate lower on Tuesday’s yield backup.  Given the last 12-years of outperformance, we understand the reluctance to look for returns outside of Tech.  But in a rising yield environment, multiples can erode despite apparently strong fundamentals.

Next: Strong economic data (February flash PMIs due tomorrow), decelerating infection rates, accelerating vaccinations and another massive fiscal stimulus package are pressuring yields higher.  From broad equity market perspective, less fiscal stimulus is now preferred.