Despite many market participants believing that a market correction was warranted, they still pursued the view of an uptick in asset pricing to prolong further. So yes, the sell-off we have experienced over the past days might have caught investors by surprise in terms of timings. However, it is interesting to analyse what triggered the sell-off primarily in equity markets.
Surely, government bonds are one of the asset classes to look at and see how their movements affect corporate bonds and equities down the line. That said the most interesting factor is to identify what triggers a movement in the yield of a government bond. Undoubtedly, there are several factors; however, what is surely of interest is the recent movement in the 10-year US government bond that triggered a chaos across financial markets.
Over the past days, we have experienced a spike in yield, thus a downward pressure in price, to an intra-day yield of circa 2.86 percent on the US Treasury. One of the primary implications of such movement was the sell-off across equity markets, which also affected other asset classes. The rationale for the said sell-off is more one of market participants digesting the economic implications of amongst others higher borrowing costs. From an economic perspective, the rationale is that higher borrowing costs will impact consumers and thus lower their disposable income, which in turn will lower their demand for goods and services, which ultimately will also affect corporate earnings. Nevertheless, obviously this is only one side of the story.
Initially investors are seeing it primarily from a monetary tightening perspective, which ultimately should result into the above-mentioned economic rationale. Markets are taking into account the recent uptick in wage growth in the US In theory, wage growth should imply increase disposable income and thereby result in an increase in consumer spending.
In my view, the recent wage growth data which is poised to increase further in the coming months is one of the principal factors that the Federal Reserve will consider in its pace of interest rate hikes. Indeed, the market is anticipating a faster pace than expected given the lower unemployment and increase in wage growth. Prior to the recent sell-off markets had priced-in three rate hikes for 2018, however the recent movement in the 10 US Treasury yield is a clear indication that the market is anticipating a faster pace of hikes.
In my view, the market still has to digest the additional pace and in this regard the sell-off momentum might not end as yet. Moving forward, my major concern would be seeing the 10 year US Treasury breaching the 3 percent perilous levels. At those levels the economic growth path might be negatively affected through the higher financing costs which will ultimately imply lower disposable income for US households. With the same line of thinking, it is important to point out that consumer expenditure contributes to circa two-thirds of US GDP. This is one of the reasons why some economists believe that US economic growth might be hindered going forward. Latest forecast shows that the US economy will grow by 2.7 percent in 2018, then slows to 2.3 percent in 2019.
It’s a fact that despite the pace of monetary tightening in Europe being different to that in the US, the market movements we’re seeing in the US are also affecting Europe. Interestingly enough this week we saw a remarkable uptick in correlation between the 10-year German Bund and the US 10-year Treasury.
In conclusion, although the aforementioned factors cannot be seen in isolation, they are surely part of the equation in terms of market movements. Many believe that the recent sell-off is just the start of a wilder ride, while others are seeing it as a buying opportunity. In the current market scenario, being diligent is imperative. This will prove crucial in protecting capital and possibly create further value in portfolios. If concerned, consult your financial advisors.
Disclaimer:
This article was issued by Jordan Portelli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.