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Why and how rate induced corrections resemble buses

Why and how rate induced corrections resemble buses

Much like buses, you wait years for a Treasury-induced sell-off and then two come along at once.

While the mayfly nature of market talking points might mean February’s correction – the last time the S&P 500 and the VIX moved this much in a day – feels a long time ago, both events appear much alike in their causality. Whether this one causes more lasting damage of course remains to be seen.

The common feature to both cases of the vapours was the sudden drop in the asking price of US Treasuries. Back then it was the very rapid move in yields from little more than 2% to the very edge of 3%, this time around an even faster dash from 2.8% to almost 3.3%.

Whatever the number, the effect is the same: stocks which have been bid to Neverland valuations on the promise of monster cash flows due to become reality sometime in the late 2020s suddenly have a much higher discount applied to their relative appeal over risk-free cash yields.

The last 24 hours have proved no exception, with the still more speculative Nasdaq leading the market lower. More generally a higher risk-free rate generically pushes risk asset prices lower.

This year may have been characterised by a persistent background hum of market-hostile news, from shredded multilateral governance rules to trade conflicts unthinkable as recently as two years ago, but macro anxiety appears to have been trumped once again by basic portfolio mathematics.

The breathless momentum and drama of plunging indices makes for great box office for the fourth estate, with Citywire no exception. But the reason why these outbreaks are so painful for the average balanced manager is that they hit both equities and bonds, with other traditional diversifiers chosen for their relative stolidity, such as infrastructure, also under the hammer.  

Wealth Manager’s own survey data shows multi-asset managers are as underweight as they can be in generic fixed income, but the overwhelming majority of portfolio managers will be constrained by regulatory – if not simply prudential - reasons to make some room for the asset class.

While the nature of the USD means that it has an exponentially larger influence on global markets than any other currency and most forecasts put us around halfway through the current Fed tightening cycle, it is probably worth also bearing in mind that we are nearer the start of a global rate repricing than the end.

Medium term benchmark euro rates have only just cleared the zero bound, and over shorter terms remain below them. Japanese rates will remain targeted at zero… probably forever.

While the weighing machine remains what you should focus on, don’t discount the probability some increasingly violent moves on the voting machine before things get easier again.      

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