Value, Bond Yields and Tail Risk
September 7, 2021
Value: August US PMI and ISM data confirmed the expanding business cycle, which helped small cap stocks (RTY Index) outperform during the last two weeks. However, value sector leadership will have to start with outperformance in Financials that require higher bond yields and more curve steepening. This week’s Treasury issuance is partly responsible for higher bond yields today. This could easily unwind if auctions look well covered.
Bond yields: Given the break in linkage between inflation expectations and nominal yields, the bond market will continue taking most of its cues from labor market data. Friday’s disappointing non-farm payroll gain of +235,000 probably lowers the bar for September’s Jobs Report due on 10/8. At this point, a +500,000-750,000 number might be enough to take 10-year yields through key resistance, the very upper-end we define as 1.46%. Though somewhat disappointing, recent data shows a still-strong economy that’s feeling the impact of the delta variant wave. It’s still possible for bond yields to breakthrough the 1.40%-1.45% range on a combination of better growth data and improving delta variant trends, but more likely to require faster job growth.
Economic tail risk: The rise of the delta variant looks like it has extended the duration of supply bottlenecks. Last month’s partial port closure in China and the tightening of restrictions in Malaysia have been cited as reasons to expect lower auto production volumes over the next several months. Keep a closer watch on input prices and transportation costs as we move further into September. Pricing pressures from persistent supply constraints always have the potential to squeeze unutilized consumer purchasing power.