The strength of the stock and bond markets relative to global growth

NEW YORK (Reuters) – It seems like something must yield on world markets.

Global equities and bonds have rallied atypically since the beginning of the year, rewarding both bullish and bearish investors on the path to global growth.

The main catalyst for gains was the Federal Reserve's surprise decision in early January to suspend its tightening policy, after four interest rate increases in 2018 raised fears that it would be too aggressive, slowing the economy and maintaining inflation. These fears contributed to the tipping of world markets in December.

However, with the US S & P 500 benchmark reaching a record high and corporate bond issues reaching new highs, the question for investors in equities and bonds is whether the next move of the Fed will be a reduction in rates that will propel more risky assets or a rise in rates the dynamics of the stock market.

A move by the Fed on interest rates or a misstep in communication from the central bank would likely end the rebound in the stock market or good-quality bonds by the end of the year, restoring thus the traditional exchange between risk and risk. security, say investors.

"The Fed is between the hammer and the anvil," said Kathleen Gaffney, portfolio manager at Eaton Vance Management in Boston. "They can not go down because there are signs that inflation is rising and they can not go up because of global political uncertainty. He leaves the market on hold. "

The US central bank has announced that it will soon stop leaving bonds bought during its period of "quantitative easing" following the financial crisis, which has also contributed to lower safe-haven returns, such as Treasuries, and acted as a tailwind for riskier assets.

Gaffney said the Fed will once again raise rates due to rising wages and other forms of inflation by the end of the year, adding that Such a decision would "pierce" the high valuations of the stock and bond markets.

TWIN RALLY

According to a Reuters analysis, the four-month sliding percentage change in the price of the S & P 500 and the 10-year Treasury Note has been positive for three consecutive months. It's the longest sequence of its kind since a five-month period that ended in August 2017, he said.

Over the same period in 2017, the S & P 500 rose and 10-year Treasury yields fell as contradictory economic reports were digested by the market during the first year of Trump's administration, before the Federal Reserve began a quantitative tightening in September, which led to a rise in bond yields. The S & P 500 continued to gather.

Since January, global equity markets have more than offset the losses they experienced in the fourth quarter of 2018, which put the US stock market on the brink of the bear market.

The S & P 500 and the STOXX 600 in Europe have grown by almost 16% so far, while the stock market indices in China have risen by almost 30%.

The US high yield ICE Merrill Lynch index is up 8.6% so far, while the Merrill Lynch World sovereign bond index has risen by almost 1.5%.

Global Equity vs. Bonds – tmsnrt.rs/2IrqXeF

The rise of 10-year Treasury bonds, generally regarded as a safe haven, undermines the image of a "risk on the market". Their yields went from 2.69% at the beginning of the year to 2.34% at the end of March.

"At this point in the cycle, equity investors are trying to positively accept new information, unlike fixed-income investors," said Jen Robertson, portfolio manager at Wells Fargo Asset Management in London. "It's pretty tricky at the moment and any negative news on the first quarter results could affect this rebound."

New uncertainties related to the economic impact of the UK's exit from the European Union, which has now been postponed to October 31, or a deterioration of trade negotiations between the US and China could to be a "shock to the system" and to derail stocks and bonds, she says.

The gap between US three-month bonds and 10-year bonds turned negative for the first time since March 2007, a bearish sign, as the reversal of the yield curve signaled an economic recession in the past.

Initially, this had the effect of raising stock prices, as investors predicted that it would prevent the Fed from facing future interest rate hikes. But stocks could soon fall if fears of recession continue to grow, said Hiroaki Hayashi, managing director of Fukoku Capital Management in Tokyo.

"If you look at past experience, stock prices have often rallied six to nine months after the initial reversal of the yield curve before leading to a major correction. I believe we are exactly in such a phase now. "

Despite huge gains this year, the financial markets have not told investors that the global economy could grow without historically low interest rates ten years after the end of the Great Recession, said Anwiti Bahuguna, head of multi-asset strategy at Columbia Threadneedle Investments.

"The bull market we have had for 10 years is mainly due to very low interest rates," Bahuguna said.

"I do not think that the equilibrium will last much longer," she added, pointing out that rising inflation and the low unemployment rate could soon put to the test. the ability of global markets to cope with a tightening of monetary policy.