The correlation indicator between the 10-year US Treasury yield and the S&P 500 index turned negative for the first time in three months, indicating that both US bonds and stocks are being sold off simultaneously. The selling frenzy of 2022 seems to be repeating itself.
The scorching hot U.S. labor market has sparked a surge in expectations of interest rate hikes, leading to a "bloodbath" in the U.S. stock and bond markets.
On Thursday, July 6th, the U.S. ADP employment report showed that the number of jobs in the U.S. private sector increased by 497,000 after seasonal adjustments in June, more than double the market's expectation of 225,000 and far exceeding the previous figure of 278,000, setting the largest monthly increase since July 2022.
The labor market continues to burn hot, not only raising expectations of a rate hike by the Federal Reserve this month, but also prompting investors to bet on a more aggressive rate hike. The latest pricing in the futures market shows that traders expect a nearly 92% probability of a 25 basis point rate hike by the Fed in July. This has caused a sharp drop in the U.S. stock and bond markets once again.
On Thursday, the 2-year U.S. Treasury yield soared to its highest level since 2007, and the 10-year U.S. Treasury yield rose above 4%, reaching last year's peak. The calm in the U.S. stock market also began to waver, with the Chicago Board Options Exchange Volatility Index (Cboe) soaring to its highest level since the March banking crisis. This index measures the fear index of expected stock price volatility.
Although the scorching labor market data dispelled concerns of an imminent economic recession, subsequent trading actions indicate that Wall Street has not yet digested the prospect of higher rates over a longer period of time.
On Thursday, Dallas Fed President Lorie Logan also indicated that further rate hikes may be needed to cool inflation, consistent with the tone of the minutes of the June FOMC meeting. The interest rate market expects another rate hike by the Fed in July, but there is still disagreement on whether further rate hikes will continue.
To make matters worse, the one-month correlation between the 10-year U.S. Treasury yield and the S&P 500 index turned negative for the first time in three months, indicating that both U.S. bonds and stocks are being sold off. The sell-off in the U.S. stock market in 2022 seems to be repeating itself.
According to Bloomberg, Harry Melandri, an advisor at Macro Intelligence 2 Partners, said:
The problem is that, for whatever reason, the slowdown in the economy is not happening fast enough.
The Fed seems to have more to do. If that's the case, many markets are a bit overextended. I don't think there are a lot of positions, but the market is not prepared for further rate hikes.
The renewed tension in the market highlights investors' unease, with yield curves from the U.S. to Germany deeply mired in inversion. Historically, such inversions have often signaled an economic recession.
However, some analysts believe that despite this, the market volatility this week is still insignificant compared to last year's turbulence. Last year's volatility led to double-digit losses in many U.S. assets and almost shattered confidence in hedging strategies. In the credit market, the spread between junk bonds and U.S. Treasuries remains close to its low point of the year, indicating that the crisis has not yet impacted broader markets. According to Bloomberg, Subadra Rajappa, the head of US interest rate strategy at Societe Generale, said that the more the Federal Reserve raises interest rates, the more severe the economic recession may be, which will ultimately lead to a rate cut. She advises clients to bet on a steeper yield curve, meaning that short-term rates may decline relative to long-term yields. However, she also acknowledges that this is not an easy trade due to market volatility.