Stocks and bonds appear to have called a temporary truce after wild volatility shook both markets.
Some stock traders say it appears equities may have set a bottom after a dramatic, multiday sell-off that seemed to start with stock investors becoming fearful of rising bond yields last week.
In the middle of it all, a crack in some funds that shorted volatility created even more uncertainty in both markets, sending buyers into bonds and sellers into stocks Monday. The stock market meltdown also made for a rush into bonds as a safe haven play. But by Tuesday, bonds were selling off, and stocks, after a series of wide swings, recovered some lost ground and steadied at higher levels.
Ed Keon, portfolio manager at QMA, said he saw signs of a bottom forming in the stock market early Tuesday. By the closing bell, the Dow had moved in an 1,100 point range to close up 567 points, at 24,912.77. The S&P 500 recovered ground after a key technical test of its 100-day moving average to finish at 2,695.14, a gain of 1.74 percent.
“Bottoming is a process. It doesn’t usually happen in one day, but we’ll see. It wouldn’t surprise me to see at one point a challenge maybe to the low from early this morning. Under these circumstances, everybody becomes a technician. I think, and I think it’s a consensus view, the overall fundamentals of the stock market are pretty good at these levels. If you look across asset classes, like we do, the bond market was not showing any signs of distress whatsoever,” said Keon.
Scott Redler, partner with T3Live.com, said it looks like the S&P 500 could see a higher open Wednesday after the “turnaround Tuesday” he was expecting. “I think the bounce could go back to test the 50-day moving average,” he said. On the S&P 500, that was 2,715. “You would think a pause would be likely. I would think that’s a good spot where the market could see some resistance. You’ll probably have to do some backing and filling before you see what’s next.”
The tensions between bonds and stocks could come to the surface again Wednesday, if interest rates rise into a key 10-year Treasury auction Wednesday afternoon. The 10-year yield was at 2.79 percent late Tuesday, after having slipped all the way to 2.64 percent overnight.
“I think we’ve had enough of a sell-off and a sell-off on the curve,” said Aaron Kohli, director of fixed-income strategy at BMO Capital Markets. “I think yields should stay here for a while and maybe even head lower.”
In the rout, as bond yields came off their highs, expectations for Fed rate hikes also decreased. Last week, the market was debating whether there were more hikes than the three the Fed forecast for this year. This week, the market gave lower odds to even the third rate hike.
Higher rates should be the result of better growth, but the stock market was spooked that inflation would start to rise quickly and the Fed would come on too strong, hurting the recovery. The market debate about rate hikes was waged last week as yields in the Treasury market rose to a high of 2.88 percent on the 10-year, making borrowing more costly for everyone from small businesses to mortgage borrowers.
Kohli said the growth outlook is too positive and data doesn’t support much lower rates. The bond market is now seeking more guidance.
“The message that really matters is the one from [Fed Chair Jerome] Powell and that hasn’t really been delivered. We’re waiting on that to make a more decisive case,” said Kohli. “I think the key case for Powell is how he addresses the market volatility. … If you view volatility as an asset class, so far the Fed has been willing to suppress it, and the real question is, is that going to continue?”
Powell took over as chair Monday, during the thick of the market sell-off. He speaks publicly before Congress on Feb. 28 when he delivers testimony on the economy. The market has been awaiting the Fed’s March meeting, where the Fed is expected to raise rates and issue new forecasts and Powell will brief the media.
Markets have been wondering if Powell, whose approach is believed to be similar to that of former Fed Chair Janet Yellen, will be soothing to markets and hold off on rate hikes if volatility is high.
Kohli said the market has to readjust to a world with volatility. He said the losses in short volatility funds sent buyers into bonds. “We went all the way down to 2.65 percent [on the 10-year]” on worries about the VelocityShares Daily Inverse VIX Short-Term ETNs. Credit Suisse said Tuesday it would close the fund.
Peter Boockvar, chief investment strategist at Bleakley Financial Group, said stocks got oversold and bounced back even with interest rates rising back to levels that unsettled the market last week.
“I think as the day went on, once you got to 2:30 or 3 p.m., and the VIX was down, people just took comfort in that maybe some of this earthquake is stopping for now,” he said. “When the 10-year broke above 2.70 last week, the selling started … that was the genesis of the sell-off. It just manifested itself in a major VIX unwind.” The 10-year yield is right back to 2.79 percent, he added.
“Buying on the dip doesn’t really die easily. It’s paid to buy on the dip every single time over the last seven years,” he said. But he warned things could still be very rocky for stocks.
“This is the beginning of a higher volatility regime, not the end, in my opinion. … driven by a rise in interest rates and a pickup in central bank tightening,” he said.
The markets became more focused on rising rates this year as other global central banks slowed or signaled they’d be willing to slow some of their easy monetary policy. The European Central Bank, for instance, cut its quantitative easing bond purchases in half Jan. 1, as the Fed also reduces its bond purchases.
Keon said he expects the 10-year Treasury yield to head higher. “If you think the market is going to rally, you expect bond yields would go back up again. I would not be surprised to see bond yields go to 3 percent in the first half of the year,” he said. Keon said the markets are adjusting fairly smoothly despite the stock market sell-off. “It’s happening very slowly and smoothly so far. Just as we saw some real volatility return to the stock market, it’s possible that could happen in the bond market too.”
Markets will be watching the $24 billion 10-year note auction at 1 p.m. Wednesday, and there are a few Fed speakers throughout the day.
Traders will be watching for comments on inflation or on the market sell-off.
Fed speakers include Dallas Fed President Robert Kaplan at 6 a.m. ET, New York Fed President William Dudley at 8:30 a.m. ET, and Chicago Fed President Charles Evans at 11:15 a.m. San Francisco Fed President John Williams speaks at a luncheon in Hawaii.