Beer is good, people are crazy
A strong rally in stocks yesterday, following the extended weekend, was driven by improved consumer data and a rally in the bond market. The correlation between bond and equity market movements is almost one to one at present; the last time this was the case was around 2000, and prior to that, in the early 1920s. There have been other moments in history when the correlation between equity and bond markets has been high, but seldom this high.
If one analyses a typical cycle, stronger economic growth initially leads to higher inflation, which subsequently results in rising interest rates, causing bonds to decline while equities continue to rise. There comes a point when tighter monetary policy slows growth sufficiently for equities to start to fall; at this juncture, markets begin to anticipate falling rates, and equities continue their decline as bonds begin to rally. Bonds are also considered a haven in times of trouble.
Recently, a lack of demand for bonds worldwide, driven by concerns that governments—particularly the US government, but to some extent most developed markets including the UK—will be compelled to borrow more to support ever-increasing budget deficits, as we discussed on Friday, has resulted in rising yields, especially at the longer maturities, undermining equity valuations. Diminished confidence in the bond market has contributed to a decrease in confidence in the equity market. The Japanese authorities announced yesterday that they are looking to control the longer end of the curve, serving as a catalyst for a global rally in bonds. For instance, the 30-year US Treasury yields, which at one point last week rose to 5.15%, were back below 5% yesterday. This, alongside a more supportive bond auction and an improving Consumer Confidence report, led to a sharp rally in US equities, which in turn sparked a rally in equities around the globe. Trump’s latest tariff U-turn has also contributed to the improved move for equities. Equity markets may fret once again when all these 90-day extensions get closer. US equities have experienced a roughly 40% round trip over the past two months, falling and rising by around 20%. The S&P 500 is now back to where it started the year.
Later today, we will receive the minutes from the last Federal Reserve meeting, followed by a wave of US economic data tomorrow. This will include the second estimate of Q1 US GDP and employment figures in the form of jobless claims. Then, on Friday, we will receive the latest inflation data via the Personal Consumption and Expenditure index, where little change is anticipated; the year-on-year rate is expected to remain around 2.5%. We will also receive the latest Michigan Consumer Sentiment survey; we will see if that report corroborates the Conference Board’s findings of an improvement in consumer sentiment. It’s a fairly quiet rest of the week for economic data in the UK and Europe.