We had prepared our usual market commentary on Wednesday morning, when the investment landscape began changing very rapidly. That text was re-written to provide a perspective view of equity and fixed income conditions.
Worries about the media-hyped surging inflation, the prospect of a series of interest rate hike beginning a next month's Fed meeting (maybe even 50 bps!) coupled with rising geopolitical tensions between Russia and Ukraine had put bond and equity prices under pressure. Indeed, the yield on the 10 year US Treasury Note slightly breached 2% earlier this month and retreated. On February 9, Euclid circulated a research piece showing that the rate rise was likely to stall at 2% and retreat, owing to overhead resistance from the Q4 2019 period.
For equities, as of last Tuesday's close, the S&P 500 was down 8.8%. The betting and sentiment was against the market: net short selling of the SPDR S&P 500 ETF grew to levels not seen since Q1 2021 while investor sentiment of expectations for stocks to rise in the next six months fell to 19%, reportedly the lowest level since 2016. Other investors were buying at a record pace options contracts that would profit in the event the recent declines continued for the stock and bond markets. A buildup of lot of negative betting and sentiment, eventually set to unwind.
When Russia launched its invasion on Thursday, bonds prices surged and US stocks got whacked in the first hour before a dramatic turnaround. As interest rates fell, the interest rate sensitive and hard-hit tech stocks surged along with the Dow and S&P 500.
There is a quote attributed to the financier Nathan Mayer Rothschild during the Napoleonic Wars: "Buy at the sound of cannons". Others have said "Buy when there is blood in the streets". We all saw the photo of a Ukrainian woman with a blooded face.
Clearly, the invasion and the flight to safety in world-wide buying of US Treasuries is making the Fed's job harder to raise rates. Economic growth now has another headwind. Borrowing by Washington to fight the effects of the pandemic pushed federal marketable IOUs to $30 trillion, which makes even a small rise in rates increasing the cost of servicing that debt which, in turn, will slow the economy.
The Fed and the administration are in a tight spot as mid-term elections are coming in November.