Bond market concerns drain risk appetite

Bond market concerns drain risk appetite

After a positive open in Europe on Wednesday, risk sentiment has drained from financial markets as we progress through the day. European stocks are a sea of red, US stock markets are poised to open lower later today and Nvidia is back to making losses after Tuesday’s near 7% rally. The root cause of the sell-off appears to be twofold: 1, the bond market, which is also selling off on Wednesday. This has caused bond yields across the world to rise sharply. It is also pushing up the French – German 10-year bond spread, which is causing ructions in the French stock market and 38 out of 40 stocks are in the red, including banks that are selling off once more. 2, concerns about the Fed pushing rate cuts further out to the future.

Are inflation pressures back to haunt markets?

Bonds are selling off and yields are rising after Australian inflation data spooked the market. Annual CPI for May rose to 4% from 3.6% in April, and trimmed mean (core) inflation rose to 4.4%. Australia now has the highest rate of inflation in the developed world, and the sharp rise in its price pressure is triggering concerns that the deflation trend is under threat and prices could rise again across Europe and the US. The drivers of Australian inflation were also concerning. Financial services and inflation costs triggered the sharp rise in price pressure in May, which suggests that core inflation is rising once again. Goods prices fell last month, which is in line with global trends. Australian trimmed mean inflation, which is the same as core inflation, also rose to 4.4% from 4.1%. This is lower than the rate of service price inflation in the UK, but it highlights the stickiness of core price growth across the world.

Why Australian CPI is weighing on global risk sentiment

It may surprise some that Australian CPI has the power to move global markets. Usually it does not, however, Australia has a westernized economy and could be seen as a lead indicator for elsewhere. Bond yields are surging across Europe and the US. The 10-year Treasury yield is higher by 6 basis points, in the UK 10-year yields are higher by 5 bps, yields are also higher by 5 basis points in France, which is putting more upward pressure on the French – German 10-year bond yield spread. Although there is no new domestic driver pushing up the French – German yield spread, when global bond market volatility spikes, this is bad news for France in the current political environment with Parliamentary elections only days away and the hard right expected to win a resounding victory.  

Hawkish Fed comments sow seed of doubt about Sept rate cut

Elsewhere, Fed Governor Michelle Bowman, said that inflation will need to fall further for interest rates to be cut, and that rates could remain elevated for some time. This has had an immediate impact on US rate expectations. Last week the market was pricing in a 65% chance of a September rate cut from the Fed, this has now fallen to 60%, which is weighing on sentiment and adding to downward pressure on bond prices, and upward pressure on bond yields.

Concentration risk weighs on US stocks yet again

Elsewhere, there are still concerns about market breadth in the US. The number of stocks that are rising in the S&P 500 is declining, as some of the mega cap tech stocks continue to dominate the direction of the US blue chip index. For example, only 113 stocks on the S&P 500 rose on Tuesday, even though the overall index closed higher. This is one of the lowest numbers for decades. The recent sell-off in Nvidia’s stock was not driven by fundamental factors linked to the chip maker, instead part of the reason was down to concentration risk. Although Nvidia had a strong recovery rally on Tuesday, it faltered once more at the start of trading in the US on Wednesday, possibly because concentration risk is still a factor that is concerning for investors in US stocks. As we move to the last few days of trading for H1, things are getting volatile.