Volatility in financial markets is on the rise, and it's clear that fixed income price action is playing a leading role in this scenario. Bond volatility is up, which is driving up volatility in equities, and we can expect foreign exchange (FX) markets to follow suit. This increased correlation between bonds and equities has negative implications for balanced investment strategies, and it's a factor that we need to contend with.
Last week, Federal Reserve Chair Powell took actions that did little to alleviate this bond/equity correlation. He indicated that it's up to the market to determine long-term interest rates, and he maintained a vague tone regarding future policy actions. The consequence of stuffing the market with a dominant safe-haven asset like Treasuries at a time when the term premium is starting to normalize and the market has witnessed the worst two-year performance in history is that it can trigger unintended consequences. While I'd hesitate to call it a rookie mistake, I'm inclined to think that Powell might be intentionally pushing the financial system towards a recession or slowdown. This would potentially lead to lower inflation and higher unemployment, which could provide the rationale for a change in policy later.
The recent massive issuance of 5-year bonds amounting to $50 billion wasn't well received, and the credit market is currently mostly closed, except for higher-quality issuers. The stabilization of rates will be an interesting development to watch. In the European Union, Lagarde stated that rates will remain at their current levels, with the expectation that this will help return inflation to target. Leading indicators of economic activity in Europe are showing signs of weakness, and recent producer Purchasing Managers' Index (PMI) data indicates a sharp deceleration, which aligns with Lagarde's statement.
This week's earnings season has produced mixed results, but the overall price action has been discouraging. Notably, the market is beginning to sell off some of the few mega-cap stocks that had been performing well, revealing underlying pain in the broader market. It's crucial to recognize that a $200 million miss in Google Cloud revenues, leading to a $250 billion market capitalization loss in mega-cap stocks in a single day, may not necessarily reflect the market's true internals.
In the corporate landscape of Europe, Mercedes issued a minor profit warning on margins, HSBC's CEO issued a stark warning to government debt issuers, Siemens Energy requested state assistance and saw a significant decline in its value, while Air Liquide and Novozymes had relatively good performance. BNP reported below expectations, but Deutsche Bank surprisingly exceeded expectations on the upside, and Santander issued a solid beat.
In summary, the big-picture risk is not offering proportional rewards, so a cautious approach is advisable in the current market environment.