On The Lookout After The Winning Streak Ends

Equity markets finally took a breather in April following a 5-month win streak when the S&P 500 appreciated 27.6% from its October 2023 lows. The S&P 500 pulled back as much as 5.4% but settled down 3.2%. The MSCI All Country World Index fell 3.1% while commodity strength helped the TSX lead for its second consecutive month, falling just 0.7%. While a pullback following such an aggressive rise is a healthy feature of any bull market, a keen eye on both Treasury yields and the U.S. Dollar will be needed as they acted as significant headwinds to risk assets.

Treasury yields rose across the curve in April, with the 10-year yield rising 48 bps to rest at 4.67%. Recall in 2023 it was around the 4.5% level where equities started taking notice, and a similar pattern may be emerging in April. Long-term yields followed, leading the iShares Trust 20-30 Year Treasury Bond ETF (TLT) to fall 6.2%, bringing its year-to-date loss to -9.7%. The U.S. Dollar as measured by DXY, rose 1.5% on the back of USDJPY rising to its highest level in 40 years. With both the US Dollar and yields acting to tighten financial conditions, markets may look for a pullback to resume their uptrend.

While equities and bonds both pulled back, commodities continued to surge. Copper followed a 4.1% move in March to rise 14.1% in April as supply constraints combined with an improved Chinese demand helped the metal follow-through on its breakout. Gold rose another 3.0%, bringing its year-to-date gain to 14.5%. While oil pulled back 1.4%, it held up better than equities and still has a 14.8% advantage so far in 2024. The combination of rising commodity prices and rising U.S. Treasury yields across the curve seem to confirm the complete 180° that market participants have taken when it comes to pricing the path of economic growth and the Fed’s reaction function around that. Throughout most of 2023, there was optimism for rate cuts based on doubts around the sustainability of inflation and/or growth for the economy. Now, there is rapid adoption of the “higher for longer” narrative where both growth and inflation are likely to remain sticky for longer. Accordingly, the six rate cuts that were priced into expectations for the Fed in December 2023 have pivoted to a 41% chance of one cut by December 2024. It is interesting that the shift comes at a time where economic data starts to turn the other way. First, a robust labour market and rising incomes has helped to sustain the growth of the economy through consumer spending. However, we’re starting to see wage growth deceleration and full-time employment fall. In the last Fed communication, Fed Chair Powell expressed concern about a wave of layoffs which would result in rapid increases in unemployment. Meanwhile Core PCE sits at 2.8% and has persistently fallen from 5.3% in March 2022. It is also hard to find wealth management firms holding material duration on their books, where only one year ago most were aggressively talking about buying the dip in in Treasury’s because it was only a matter of time before inflation fell. Weak price action keeps us from front-running any shift, but consensus has shifted rapidly in 2024, and we would not be surprised to see any potential sign of economic or inflation weakness lead to some kind of bid in bonds. Recall U.S. bond yields hit their 20-year high in October 2023 and have not broken through that top.  Vigilance will be necessary to detect when price action starts to sniff out a high in yields.