As the Federal Reserve prepares for its annual symposium from Aug. 24-26 in Jackson Hole, Wyoming, markets are trying to come to grips with the latest move higher in yields post the Federal Open Market Committee (FOMC) and the recent U.S debt downgrade which has seen long end yield rise and a resurgence of the U.S dollar. From this we take a look at which sectors have been impacted and where potential opportunities and pitfalls may arise. This month has seen a move higher in cash rates from the U.S. Federal Reserve, the Bank of of England, the European Central Bank and even the Bank of Japan has hinted the it may relax it’s strict policy on Yield Curve Control (YCC) allowing longer term yields to rise while the Reserve Bank of Australia maintained its current cash rate. The bigger part of the move in rates has come this week has come following from the most recent announcement from ratings agency Fitch which downgraded U.S. long term foreign currency ratings to AA+ from AAA. Since the last FOMC meeting yields on 10 year have move more than 30 basis points higher from 3.85% before finishing just below 4.19% yesterday.
The recent back drop of high inflation has seen central banks across the globe lift short term rates to combat a problem, which post Covid, seems to have been far more persistent than most central bankers would have imagined. The big concern lies in what form any potential slow would like like given the higher borrow costs and increased cost of living, also helped higher by the War in Ukraine, supply chain issues, and a shortage of labour supply have all contributed to. Markets have grappled with a U.S yield curve which has fallen from a high near +160 points in April of 2021 to the recent lows near -110 as short term rates have pushed higher and the rise in longer term rates has not kept up. This week’s debt downgrade has seen longer term yields accelerate to the upside and the spread between the 2 and 10 year treasury notes has narrowed from -110 to be currently trading near -70 basis points.
Markets have responded by switching away from assets which generally benefit from lower rates such as technology stocks which sees their valuations benefits when compared to and using lower yields for assessing value and also cash flows. The U.S dollar index has found renewed support and has also pushed higher now making exports dearer and weighing on commodity prices and while the most recent data seems to suggest a slowdown in the rate of inflation, labour markets continue to show resilience and tonight we get the Latest look at the monthly Non Farm Payroll numbers for July. Technology stocks which have been at the forefront of this year’s outperformance, in particular the Nasdaq which is currently up 33.36% for the year compared to the likes of the Dow Jones Industrial Average +6.24% and S&P 500 Index +17.25% could be in for some rotation back into more traditional sectors such as industrials when you consider the extent of recent moves which has seen the likes of Microsoft which has fallen 10.94% since its most recent high, along with Netflix -11.13% and Tesla -12.96%. In the semiconductor space the iShares Semiconductor ETF (SOXX) has fallen 5.53% in the last 3 days since the ratings downgrade. Whilst it may all seem like doom and gloom this week it must also be remembered that some of the above mentioned names and sectors have been among the top performers for the year and despite recent declines NVidia Corp is still +204% for the year and Advanced Micro Devices +74% on a year to date basis and being helped higher with the latest buzz in Artificial Intelligence.
So where to from here begs the question. While the Federal Reserve looks to be taming the inflation giant and may still have a rate rise or two up its sleeve, it does not mean they will immediately switch from hiking to easing rates. The shift from a tightening bias is probably a little further away than most anticipate but none the less showing glimpses of what may come down the track. The obstacles that need to be overcome is the resilience of the U.S. dollar and the length inversion of the yield curve. What this week’s ratings downgrade showed us is that markets do not kindly take uncertainty pushing up volatility in equity markets and this was very evident in March of this year with the issues surrounding Silicon Valley Bank. My initial thoughts given the events of the past week would be to look to continue to rotate away from the Nasdaq and into the broader S&P 500 index and look for the gap in performance to continue to narrow and the same applies for the spread between the 2 and 10 year yields which has already seen a large swing in sentiment this week so this one could be worth being somewhat more patient with.