It’s all about rising bond yields again but complacency reigns for US equities

• US Treasury yields have started to rise ex post US CPI and PPI data releases.
• Equities, commodities, fixed income, and cryptocurrencies have started to pull back from earlier rallies.
• VIX, a measurement of implied volatility on the S&P 500 has sunk to a 14-month low.

The US regional banking systemic risk that spooked the international financial markets last month has subsided and taken a back seat.

The focus for market participants is now tilted back to Q1 2023 earnings results primarily in the US where analysts have a downbeat assessment of the benchmark S&P 500 index. Based on data from FactSet, the aggregate earnings forecast of its component stocks for Q1 is expected to come in at a year-on-year decline of -6.5%; its second consecutive quarter of contraction. If such a forecast turns out as expected, it would mark the largest earnings decline since Q2 2020 (-31.6% y/y) and constitutes an earnings recession in the US.

Also, the fixed income market will be of interest too as the movement in the yields of the US Treasuries tends to impact the funding costs across the entire spectrum of financial assets. The yield of the US Treasury bond or note is the international benchmark risk-free rate; the universal factor to price most financial assets. All things equal, higher yields will tend to translate to lower prices for risk assets such as equities and high-yield corporate bonds because of a direct and indirect (time value of money discounting) higher cost of funding factor that reduces revenue growth.

Its time to pay attention to rising US Treasuries yields

Interestingly, the 2-year and 10-year US Treasury yields have increased since 13 April, ex-post US CPI, and PPI data releases. The 2-year Treasury yield which is more sensitive to the Fed’s monetary policy has increased by 28 basis points as of yesterday, 19 April, a 4-week high. As for the 10-year Treasury yield, it rallied by 15 basis points over the same period. In addition, both yields are now back above their respective key 200-day moving averages for three consecutive sessions after they traded below for a brief period during late March during the onset of the US regional banks turmoil.

Source: TradingView as of 20 Apr 2023 (click to enlarge chart)

As seen from the chart above, the minor bullish breakout seen on the 10-year US Treasury yield on 14 April has led to recent retracements of the prior rallies from early March on a spectrum of different assets; equities (S&P 500 & Nasdaq 100), fixed income (US Treasury Bonds), commodities (WTI Crude & Gold), Cryptocurrencies (Bitcoin & Ethereum).

Perhaps, US Treasury yields are playing catch-up due to potential mispricing on the increasing bets that the Fed will start a fresh interest rate cut cycle as early as July this year without considering a firm US breakeven inflation rate, more details over here in my previous write-up.

 US equities are still in a “joyful” mood

Source: TradingView as of 20 Apr 2023 (click to enlarge chart)

Despite this inherent risk of rising bond yields, the US stock market is still singing to a tune of complacency as the CBOE VIX index, a measurement of the implied volatility of the benchmark S&P 500 sunk to a 14-month low of 16.94 yesterday, 19 April.

An interesting observation to note is that the current level of VIX is now coming close to a key inflection level of 14.94 which has led to prior two bearish reversals seen in the S&P 500 on 28 March 2022 and 8 August 2022. Hence, perhaps it’s time to be a bit fearful.

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