Stocks extended their losses today despite a retreat in key Treasury yields. The Dow Jones Industrial Average dipped by 0.4%, a 140-point descent, while the S&P 500 declined by 0.8%. Both indices are veering toward a negative close for the week, following the substantial sell-off on Thursday. The tech-heavy Nasdaq Composite wasn’t spared, experiencing a 1.25% fall.
This market reaction was triggered by Powell’s indication that the Fed remains steadfast in its “higher for longer” interest rate policy, a move that has driven Treasury yields upwards. Notably, the benchmark 10-year yield briefly touched the 5% mark late on Thursday, a level that market watchers haven’t seen since July 2007.
Greg Whiteley, a portfolio manager at DoubleLine, conveyed the market sentiment succinctly: “The underlying message is ‘don’t be looking for a bailout from the Fed anytime soon.’ That gives people the go-ahead to take rates above 5%.”
In a twist, the yield on the 10-year took a step back from that pivotal level today, falling to around 4.91%. This move is part of a wider recovery in fixed-income assets, suggesting that the worst may finally be over.
Investors, in their quest for some positive momentum from earnings reports, found no solace, even with several strong financial performances on the books.
Adding to the market’s shaky stance is the looming threat of the Israel-Hamas conflict escalating into a broader Middle East confrontation. This concern intensified after Israel’s defense chief suggested a possible ground assault on Gaza in the coming days.
In the midst of these tensions, there’s a growing consensus among market participants advocating for a rebound in 10Y Treasuries. This sentiment strengthened particularly after Morgan Stanley highlighted the 5% mark as a “great entry point” for those looking to increase their Treasury positions.
Vishal Khanduja, a money manager at Morgan Stanley Investment, noted, “Those will be great levels to get longer in your portfolio from a duration perspective” under the current conditions. He added, “We’ll be superbly in that overshoot category” if yields exceed 5%.
Khanduja is also betting on a steeper yield curve, a logical strategy considering that once the Fed initiates rate cuts, they’re likely to be substantial, causing the curve to steepen dramatically.
This strategy has been fruitful, as the surge in the 10-year bond yield has significantly reduced the negative spread with the two-year note, a trend that Khanduja expects to reverse into a positive spread, although he anticipates a longer timeline for this shift.
The expectation now is that the Fed may hold off on rate cuts until the end of 2024 or early 2025. However, with the most aggressive rate-hike cycle since the 1980s likely reaching its conclusion, Khanduja believes that a steeper curve and term premium have effectively tightened policy on the Fed’s behalf.
This perspective is not exclusive to Morgan Stanley, either; Goldman’s derivative strategist John Marshall shares a similar bullish outlook for Treasuries, expecting a temporary slowdown in the macro environment in the fourth quarter to skew risks towards lower yields, dropping from the current 4.91% to around 4.2-4.3%.
Marshall cites several factors contributing to this view, including ongoing core disinflation, a pause in the Fed’s rate hikes, and anticipated weak economic data. Additionally, increasing geopolitical uncertainty could prompt a flight to safety, driving yields down further.
In response to these dynamics, Goldman recommends buying calls on the iShares 7-10 Year Treasury Bond ETF (IEF) to hedge against the potential decline in yields.
Echoing this sentiment, UBS desk trader Rebecca Cheong suggested that the bond market hit a capitulation point on Thursday, potentially marking the end of the current multi-asset unwind cycle. She anticipates that this shift will stabilize retail sentiment and possibly make current sell-the-dip behavior a temporary phenomenon.
With the buyback blackout period ending today and the Fed entering a communication blackout, Cheong’s advice to “buy the dip” in equities at current levels, especially given the typical strength in the remaining part of October and November, seems like a sound strategy amidst the ongoing market volatility.
