How long can the market hold up against a similar rise in bond yields? How long, in fact, will the central banks (Fed in the lead) still be able to kick the jar forward and postpone the choice between the only two options left, before the system goes out of control?
Options that, objectively, turn out to be one worse than the other.
Before, abandon the perennial Qe and begin a normalization of monetary policy which, in this moment of the combined effect of the Covid effect on the economies and the equity market in bubble, it would mean earthquakes and an assured corporate default chain.
Second, en masse to follow the Japanese recipe of direct control over the yield curve, in order to impose a cap de facto at rates. Road, the latter, tends to have no exit. And with a disastrous ending, at least in the medium term.
The market has come to a showdown and, once again, the role of the detonator was played by hedge funds: as this graph shows, it was precisely the flight from the bond of hedge funds – short as never before on Treasuries – that accelerated the sell-off which sent the US ten-year yield even in the 1.60% area, thanks to a disastrous 7-year bond auction.
And this other graph shows the reason for this move: Equity and fixed income investors both benefit from the negative structural correlation between equities and bonds, as this suppresses volatility and allows entities such as risk parity funds to apply leverage. greater.
The problem is when, like today, that correlation becomes positive and, consequently, volatility grows: at that point, take the de-risk by investors. The sales. Often, cascading, since they are imposed by the VaR models relating to the book values of the assets.
And what actually happens in a VaR model when similar dynamics are triggered? These two graphs show us, the first of which photographs the situation that arose when the US ten-year yield reached 1.47% yield: that yield equalized the dividend paid by the Standard & Poor’s 500, effectively opening a huge window of investment alternative (especially foreign) to ultra-valued US equities.
The risk? Sell-off equity, since the return you go to look for it on fixed income, betting on further growth in rates. The second graph, then, shows how the increase in the yield on the US ten-year could detonate the already ticking bomb of the tech sector, impacting the entire stock market in a cascade.
It is close to reaching the 2% gap (today around 2.2%): that level, in fact, would be the last degree of resistance, before fall-out. Ignored until today, as only at the end of 2020 no one would have bet a cent on such a jump in rates.
But, as the third graph shows, no longer ignorable, given the direct correlation recorded in real time today. For this, in one way or another, the Fed will have to intervene.
And stop bothering with announcements like those reiterated by Jerome Powell in the two days of hearings in the Senate, capable only of postponing the inevitable for a few hours.
And this last graph shows how what is happening has almost immediate consequences – in the pricing of futures – also on macro developments:uptick highlighted in fact represents the implicit probability rate of an entry into recession for the US economy.
Within a year. Not much, apparently. But the same Bloomberg had to admit in the subtitle of the graph what the reality is: that though, although, it says it all. The increase, albeit modest, must in fact be related to the magnitude of the support intervention already underway (and active since last March), between federal support plans and Fed purchases.