Higher Yields Are Removing A Cautionary Signal For Markets


October 28, 2016, 5:15pm EST

Remember, up to mid 2015, there were reasons to be optimistic about the outlook for the global economic recovery. The U.S. economy was improving.  With the job market hitting targets, the Fed was preparing the world for the first rate hike, to begin moving away from emergency policies.  The BOJ was keeping its promises of going full bore into an aggressive easing program which had driven the yen much lower, and stocks much higher, which was beginning to reflect in the economic data.  And the European Central Bank had finally started an aggressive easing program to deal with deflationary malaise in the European economy.  Better data plus continued aggressive global stimulus was reason to believe better times ahead.

But then came a jolt to markets by the Chinese making an about face on their currency (from strengthening to weakening).  That created question marks about the health of China.  Were things there worse than people think?  And is China beginning to respond with a mass currency devaluation?  That shook markets and confidence.  And then we had the oil price bust early this year.  That threatened mass industry defaults, and a spread to the global financial system.  That shook markets and confidence.  And, of course, we’ve had the surprising vote from the UK to leave the European Union (Brexit).  That shook markets and confidence.

In this environment, stocks (especially U.S. stocks) are a key barometer of confidence.  And it becomes self-reinforcing.  When confidence shakes, stocks go lower. When stocks go lower, confidence wanes more.  Weak confidence starts reflecting in weaker economic data. Weaker economic data pushes stocks lower. And the circle continues.

With this said, for much of the year, there has been speculation of another recession coming.  The interest rate market had been pricing in a deflation forever story, with $12 trillion worth of global government bonds in negative yield territory at one point this past summer.

And despite the fact that the intensity of the macro concerns has abated, the fall back in the interest rate market was still sending a very cautionary signal to markets. That caution signal looks like it’s lifting.  U.S. 10 year yields look like a run back above 2% is coming soon.  And most importantly, the yield on German 10 year bunds (another key global benchmark interest rate) has been on a tear, exiting negative yield territory this week and running up to levels not seen since the day of the Brexit vote.

This move higher in rates, from record low levels, should be good for confidence, good  for the economic outlook, and therefore good for stocks (as it removes the another cautionary cloud over sentiment).

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