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Wall Street’s reversal curbs bond trader euphoria

The New York Stock Exchange is shown in New York.  (Victor J. Blue/Bloomberg)
By Rita Nazareth Bloomberg

The world’s biggest bond market saw a day of reversals, with Treasuries paring their weekly rally as strong economic data reinforced the view that it may be too early for the Federal Reserve to claim victory over inflation.

At the end of a week marked by optimism the Fed would be closer to ending its interest-rate hikes, a report showed consumer sentiment soared to an almost two-year high – while short-term price expectations rose. Bonds reacted immediately, with the front-end of the U.S. curve bearing the brunt of the selling. Stocks posted mild losses as traders cited “consolidation” after a rally that still drove the S&P 500 to its best week since mid-June.

“This doesn’t look like ‘mission accomplished’ yet,” said Don Rissmiller, one of the founding partners of Strategas, referring to the economic data. “The most important variable for consumer spending remains employment, which is still solid. But the tight U.S. labor market also is key for long-run inflation considerations.”

The two-year U.S. yield, which is more sensitive to imminent central bank moves, climbed 13 basis points to 4.76%. That’s a stark contrast to the slide in rates over the past few days. The dollar posted a mild gain, trimming its largest weekly rout since November.

Investors also sifted through results from JPMorgan Chase, Wells Fargo and Citigroup, which benefited from higher interest rates – but easily beat lowered analyst estimates. UnitedHealth Group’s surged as profits allayed fears of runaway medical costs. AT&T sank to a 29-year low amid growing concerns about potentially higher costs for the phone giant.

Equity strategists are boosting earnings forecasts for the S&P 500 over the coming year faster than they are marking them down, pushing a key indicator tracking the momentum of analyst revisions well off its November nadir.

After hitting negative 70% late last year, this metric – which focuses on forward earnings-per-share over 12 months – is closer to positive territory at minus 28%, according to data compiled by Bloomberg Intelligence. The indicator has been touted as a forward-looking gauge on the profit outlook that may support the case for stock gains over the coming year.

U.S. economic data has been encouraging, and the likelihood of a soft landing improves with every data point demonstrating resilience, according to Solita Marcelli at UBS Chief Investment Office. However, she maintains her preference for high-quality bonds over equities for three reasons.

“The good macro news is already priced into the S&P 500,” Marcelli noted. “In the second half, we expect an environment where inflation continues to fall, but U.S. growth also slows. That situation is good for bonds, but generally not equities. Third, the uncertain scale of the lagged effect of prior interest rate hikes means that both recession and a Federal Reserve policy error remain potential risks.”

Bank of America’s Michael Hartnett, who was correctly bearish on stocks last year, says market optimism that the economy will run neither too hot nor too cold is unlikely to last.

“Goldilocks rules risk assets for now,” but the second half is likely to bring higher consumer-price inflation, policy tightening and savings, the strategist wrote. “We’ll look to short risk assets in late-August or early-September and note a big, fat secular trading range remains the base case.”

Fed officials, on their part, continue to sound cautious.

Late Thursday, Governor Christopher Waller said he expects two more rate increases this year to bring inflation down to the 2% goal, though more good data on prices could obviate the need for the second hike. Fed Bank of Chicago President Austan Goolsbee told Fox News that recent consumer-price data was “promising,” though inflation is still higher than the target.

To Krishna Guha at Evercore ISI, it should come as no surprise that Fed policymakers – even less hawkish officials – are striking a wary tone.

“This serves the purpose of retaining an option – even if it is now an out-of-the-money option – to hike a second time late in the year if the data surprises to the upside,” Guha added. “But it is also a way of keeping market rate-cut expectations from being pulled forward too much.”

Swaps pricing show expectations that the Fed is virtually certain to raise its benchmark rate by another 25 basis point when it meets later this month, with a roughly one-third chance that the central bank will make one more such move before stopping its cycle.

Elsewhere, gauge of emerging-market currencies saw its best week since January. Oil notched its third weekly advance, but fell on Friday as traders locked in profits and the commodity’s 200-day moving average again provided a barrier to further advances. Crude still notched its third weekly advance.