A fascinating analysis of the Fed’s announcement Wednesday along with the recent reversal of 10-year treasury bond rates (falling from 1.75% to below 1.5%). After the Fed’s (seemingly more hawkish) statement on interest rates, yields on longer dated bonds actually fell late in the week while shorter term rates spiked higher.
Can’t do justice to Forsyth’s excellent article, but
here’s a few snippets: “The calls for the Fed to slow or even end its monthly purchases of $40 billion of mortgage securities have become more widespread. On that score, Bullard (James Bullard, president of the Federal Reserve Bank of St. Louis) appeared to be in agreement. “I’m leaning a little bit toward the idea that maybe we don’t need to be in mortgage-backed securities with a booming housing market,” he said. “I would be a little bit concerned about feeding into the housing froth that seems to be developing.”
Even without the Fed reining in its bond buying—which pushed its balance sheet past $8 trillion as of Wednesday, nearly double its prepandemic size—Lori Calvasina, RBC’s head of U.S. equity strategy, thinks the decline in the 10-year Treasury yield during the second quarter may be signaling a slowing economy. That thesis was proposed in this space a week ago.
The slippage in long Treasury yields could portend a slump in the widely watched ISM gauges, which she says may be associated with either a pause in the leadership in cyclical stocks or a pullback in the overall market. In that case, she suggests adding to classic defensive groups such as consumer staples, utilities, and healthcare to ride out a short-term pullback. Financials, energy, and materials, which had been leading the market, still make sense longer term, while industrials lack appeal because of valuation, she adds.
Emanuel (Julian Emanuel, chief equity and derivatives strategist at BTIG) also prefers exposure to defensive groups such as healthcare, because he looks for bond yields to resume their ascent, with the 10-year Treasury heading toward 2%, posing a headwind for equities. At the same time, he’d avoid transports and high-multiple secular growth stocks, which are sensitive to higher yields.
And he’d play a rise in volatilities with options. In a client note, he recommended a straddle, simultaneously buying July 30 calls and puts on the S&P 500 index, a position that would pay off from big moves higher or lower but would lose the cost of premiums paid on the options if the market stays range-bound. If July brings fireworks beyond the Fourth, however, the bet would be a winner.“Barron’s June 21, 2021
