US Treasury bond yields spike and the Dow Jones mini-crash
Even though january jobs growth was only 200,000 and the unemployment rate was 4.1 per cent, the US Treasury bond market was spooked by unmistakable evidence of stronger wage growth, a proxy for Wall Street’s dreaded inflation risk. The yield on the 10-year US Treasury note, 2.20 per cent last September and 2.40 per cent on New Year’s 2018, has spiked higher to 2.85 per cent, the highest in four years. The bond market bloodbath led to an ominous (that devil number again!) 666-point fall in Dow Jones Index on Friday.
Financial markets now price in four, not just three, FOMC rate hikes, in 2018 (I have argued for five hikes in this column ad infinitum) as the reality of higher wage inflation, a higher budget deficit and dramatically higher US Treasury debt issuance sinks in. Wage inflation means core consumer price inflation index could well rise well above 2.5 per cent by this summer and force the new Fed Chairman Jay Powell to respond to prove that the US central bank is not behind the inflation curve. This will resurrect the ghosts of the bond market vigilantes of the Clinton-era in the 1990s.
Fear has now replaced greed in the stock market. The Chicago Volatility Index has risen from 11 to 17. Technology momentum stocks that disappointed on earnings reports like Apple and Google have been gutted. Exxon Mobil was shredded after it missed its EPS estimates and took its supermajor peer Chevron down with it. The leak of a FBI memo on Trump’s Russia “dossier” complied by a British ex-MI6 intelligence officer has also unnerved stock market bulls about rising political risk in Washington. The Federal Reserve’s surprise demand that Wells Fargo replace four board members and restrict its asset growth until it improves its governance/risk compliance protocols has also spooked investors who expected Powell to be a “light touch”, anti-Dodd Frank, laissez-faire regulator since he was handpicked by President Trump to replace Janet Yellen. With narrow breadth, no sector leadership and a 10-year Treasury note yield headed well above 3.25 per cent, it is premature to bottom-fish in the US stock market, though I see value creeping back into my favourite names.
The S&P 500 index witnessed its most traumatic week since January 2016, when fears over China’s yuan devaluation and a plunge in Brent crude below $30 led to a 15 per cent fall in the bellwether US stock market index. The prospect of more aggressive Federal Reserve rate hikes in 2018 has also boosted the US Dollar Index above the 88 low it hit on Steve Mnuchin’s Davos comment, the reason crude oil, gold and silver got slammed on Friday. The acceleration of the Treasury bond market sell off has now spread contagion to US equities and global risk assets. It is too early to speculate if the US dollar will be sustained by a “safe haven” panic flows from Europe and Japan, as happened just after the failure of Lehman Brothers in 2008. Yet four Fed rate hikes in 2018 even as the American central bank begins to aggressively shrink its balance sheet this summer means the euro could be a strategic short at 1.25.
This is all the more true since Deutsche Bank’s woes mean Dr Mario Draghi, President of the ECB will be forced to delay his planned taper until December. If this happens, I can easily see the euro plummet to 1.16 and take Brent crude down to $56-$58, both policy objectives of Super Mario if he heeds my call. This was the message of the traumatic liquidation in the German DAX index and Big Oil to me. Average hourly earnings at a nine year high mean that even a Trump yes man like Powell can do nothing to prevent aggressive monetary tightening by the FOMC conclave he will head in June, November and December. At a minimum, the balance of risks has shifted to four interest rate hikes in 2018.
Fed Funds futures implied just two rate hikes in 2018 after Dr Yellen’s FOMC hiked rates in December 2017, with only 30 per cent odds of three rate hikes. Fed Fund futures now imply a 70 per cent probability of three rate hikes and 20 per cent odds of four rate hikes in 2018. The world has turned uglier for stock market bulls and leveraged bond market bulls are on the road to financial suicide, assisted merrily along by a fee-driven Private Bankerji. After 35 years, the epic bond bubble will pop with a vengeance that will shake the world.