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Global Markets: Equity markets drop amid continued volatility, bond yields flat

Global Markets: Equity markets drop amid continued volatility, bond yields flat

Closer analysis of bond market performance shows that ten-year nominal yields have moved higher than their equivalent maturity treasury inflation-protected securities year-to-date. "This market is not going to go up forever, and rates aren't going to stay stable forever".

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 USA stock market index.

The dollar index.DXY rose 0.49 percent, with the euro last EUR= up 0.06 percent to $1.2375.

LPL Research released a report titled "Volatility is Back", which pointed to fear of rising interest rates as the source of the recent swings but cautioned that the economy is fundamentally strong. While perhaps not the overriding factor, the oil price will be worth monitoring to see if any significant and sustained correction precipitates a halt to the current bond market sell-off.

Overseas market jitters mostly eased after plunging earlier this week.

Rory McPherson, head of investment strategy at Psgima IM, said investors should expect more volatile markets heading into 2018, as this is the first year where the marginal buyer of bonds is not a central bank.

"What is says, in general, is that higher interest rates make stocks look more expensive, especially relative to a fixed-income alternative", said Tim Ghriskey, managing director at Solaris Asset Management.

"We're in this interest rate bed all together". "The links are always tenuous and squishy at best". The 10-year was at 2.84 percent Wednesday afternoon, after edging to 2.86 percent, just under its high for the week of 2.88 percent. It's the opposite of something that has bugged stock bulls for years, the flattening yield curve, which can imply moribund expectations for long-term growth. A soft 10-year auction added to the jump in yields, which move opposite prices. Rock-bottom financing costs have been a boon to earnings for a decade, a period in which the Federal Reserve has held rates near zero.

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Monday's historic slump in United States stocks had something to do with this. The S&P 500 and Nasdaq were also firmly in the red.

"The dust hasn't settled yet, and I think both buyers and sellers are trying to figure out what this market really wants to do", said Jonathan Corpina, senior managing partner for Meridian Equity Partners in NY. In fact, oil prices have risen more than 40% since June 2017, with the trend gathering momentum since November when OPEC and Russian Federation agreed to extend production cuts. But they're going up now at a time when anxiety about the monetary policy is obviously on the rise.

Nor is the Fed alone in adjusting policy - the European Central Bank has reduced its monthly asset-purchase target and hasn't decided whether to extend buying after September.

Recent U.S. tax cuts that may spur economic growth, the prospect of more government borrowing to fund a widening fiscal deficit, and rising wages, have all pushed up benchmark U.S. Treasury yields to near four year highs.

The yield on the 10-year Treasury bond ticked higher again on Thursday morning, to 2.88%.

It's healthy and normal for equity markets to experience pullbacks - average annual drawdowns in any given year can easily exceed 10% (historically the average largest intra-year decline for the S&P 500 would be around 13%, for example) and on average still deliver positive total returns on a full year basis.

But Wall Street is still nervously watching the bond market, where the trouble started last week. The firm manages US$179 billion.

"A strong currency keeps a lid on inflation, which in turn helps keep interest rates low", she said. "There's both a market valuation explanation and a fundamental economics mechanism".