“The market had to calm down and it has calmed down”, observes, a bit relieved, a bond manager. The less warlike tone than expected of the publication, on Wednesday, of the minutes of the last monetary policy meeting of the American central bank, which was held on May 3 and 4, has already made it possible not only to stem the fall in US stock market indices, which had been falling for 8 weeks for the Dow Jones, but also to continue the decline in rates. The slowdown in inflation in the United States in April (+6.3% against 6.6% in March) did the rest.
As a result, driven in particular by Tech and luxury stocks, the equity markets are not far from concluding their first week of increases in two months. As for rates, they are back at levels closer to those desired by the central banks, as if the markets were once again in tune with the Fed’s rhetoric. Thus, the 2-year rate in the United States has returned to around 2.5%, after having flirted with 3.5%, and the American “ten-year” rate seems to have stabilized around 2.8%.
The yield curve thus returns to its pre-Covid crisis configuration: flat. A little as if the bond market had tested a peak before coming to its senses. Especially since the scenario of an upcoming 75 basis point hike in the Fed’s key rates now seems to be receding.
A normal return to normality
The Fed will certainly continue to normalize its policy because it must do so after the health crisis. Admittedly, inflation remains high, but this inflation is largely fueled by energy prices on which the central bank has no leverage. It is not indeed a rise in rates that will stop the war in Ukraine or decide China to lift its foot on the confinements. However, the message from the FOMC minutes suggests that the Fed could slow its rate of increase in 2023 in the event of a recession. A breath that immediately benefited equities and growth stocks in particular.
As a result, investors in the euro zone are also reassured: American moderation prevents European rates from skyrocketing. Admittedly, the ECB will begin to raise rates faster than expected, but to reach a zero rate at the end of the third quarter. Nothing could be more normal after all, even though the key rates of the ECB are still in negative territory (-0.5%)!
On the credit front, the situation remains feverish with a prevailing feeling of the risk of recession. The iTRaxx Main index, which measures the cost of protection in the event of default, remains at very high levels, between 90 and 100 basis points, after hovering around 50 in recent years, with the exception of the beginning of the Covid crisis when it climbed to 140 to come down just as quickly.
Rates guide the market more than ever
A lull in rates could have ripple effects throughout the market, and especially in equities. After the sharp decline in recent weeks, almost interrupted since February 24, the date of the invasion of Ukraine by Russia, investors are waiting for a signal to return to equities, whose excess valuations have been purged. Especially since the latter are full of cash. A rally in equities cannot therefore be ruled out.
Of course, analysts will continue to scrutinize retail earnings and corporate earnings or forecasts. The textile chain Gap thus lost almost 8% following the drop in its profit forecasts. Technology stocks – the Nasdaq which has rebounded 6% over the week while remaining down 25% since the start of the year – remains the point of uncertainty: is the purge over or the liquidation period? ongoing. The evolution of rates will be a key element of the answer.
Over the week, the rebound is significant: the CAC 40 returns to the 6,500 point threshold at 6,515.75 points, an increase of 3.67% in five sessions. The Stoxx 600 index has gained almost 3% since Monday. The rise is more marked in the United States, with an S&P 500 index which takes up almost 6% and the Nasdaq, the index of technological stocks, which is also heading towards a 6% gain in five sessions.
The market is probably at a crucial moment: either it is rebounding from the bottom, or the downtrend is confirmed. Inflation news will be the judge of the peace.