Stocks Slammed By Bond Market Stress
2022.10.11 10:27
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- Cracks appear in UK bond markets again, sterling resilient so far
- Nasdaq hits two-year lows as rising yields hammer riskier assets
- Dollar reigns supreme, keeps sinking on China worries
UK turmoil
Another sharp selloff rocked British bond markets this week, reigniting fears of a debt crisis in the world’s fifth largest economy. With investors dumping UK bonds in force again, borrowing costs have spiraled to the highest level since the Bank of England stepped in to ward off a pension fund collapse.
Investors hit the panic button after the BoE announced it will double the maximum limit of its daily bond purchases to inject more liquidity into stressed markets, but committed to phasing out this lifeline later this week as originally planned. Markets anticipated an extension given the long-term nature of these issues, and when the BoE refused, the selloff resumed with a vengeance.
Sterling was quite resilient though, losing some ground but nothing on the scale of the previous bond market storm, when it touched a record low against the dollar. This FX calm suggests the selloff is more orderly this time, not driven by big players forced to liquidate assets in a fire sale to meet collateral requirements, even though yields are trading at similar levels.
Looking ahead, the outlook for the pound remains gloomy. The nation’s twin deficits continue to balloon and the BoE is reluctant to raise rates aggressively, worried it will deepen the recession it has penciled in and generate more instability in the financial system. Ultimately, these deficits leave sterling vulnerable to any shifts in risk sentiment, which is already on shaky legs as the world economy powers down.
Wall Street trouble
Wall Street declined for a fourth consecutive session. The rate-sensitive Nasdaq briefly touched a two-year low as the turmoil in UK bonds went global, pushing yields back to their cycle highs and leading investors to dial back their risk-taking behavior. Some warnings from JPMorgan (NYSE:) chief Jamie Dimon that the US economy will likely enter recession and that stocks could fall “another easy 20%” didn’t help.
Dimon’s warnings echo what the bond market has been screaming for months now with the deeply inverted yield curve, which is typically a harbinger of recession. Valuation multiples are still too expensive for this higher interest rate regime, the world economy led by Europe and China is losing momentum rapidly, and a cascade of earnings downgrades is looming once the reporting season kicks off this week.
The big fear around this earnings season is not the results for the third quarter, but rather what corporate executives see on the horizon. Companies have been rushing to reduce their earnings guidance lately, with Nike (NYSE:) and AMD for instance putting the blame on macroeconomic forces. If this trend persists, the rosy profit estimates for next year could be slashed, raining fire on stock markets that are already on the verge of a breakdown.
Dollar still king, gold drops
A trifecta of favorable interest rate differentials, safe-haven flows, and an absence of any attractive FX alternatives continues to power the engines of the fast-and-furious US dollar. Across the risk spectrum, commodity-linked currencies such the Australian dollar have been demolished by the sharp declines in equities and worrisome news flow out of China.
Gold suffered heavy losses too, as the rampaging US dollar joined forces with real US yields that briefly hit new cycle highs to wreak havoc in the commodity complex. As long as this toxic combination is in effect and a Fed pivot is not imminent, the path of least resistance for bullion remains lower.
As for today, the calendar is loaded with speeches from prominent central bankers including ECB chief economist Lane (13:45 GMT), the Fed’s Mester (16:00 GMT), SNB Chairman Jordan (16:00 GMT), and BoE Governor Bailey (18:35 GMT). 
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