You won’t believe what just happened! A shocking twist that will blow your mind – Financial Times

Title: The Shifting Landscape of Market Trends: Exploring Recent Changes and Their Impact

Introduction:
In recent weeks, the markets have experienced a significant shift in trends and dynamics. This article delves into the underlying factors contributing to this transformation and examines the potential implications for investors. We will explore the rise in long-term Treasury yields, the persistence of low inflation expectations, and the noteworthy increase in stock prices. Additionally, we will address the implications of these developments and discuss whether the market may be overly optimistic.

The Current Market Shift:
Over the past few weeks, the markets have undergone a noticeable change that appears to be more than just a temporary adjustment. While short-term market moves can often be a result of changing investor positions, this recent shift seems to bear more significance.

Economic Data and Key Indicators:
The backdrop for this market transformation is the array of economic data that has recently been released. Durable goods and gross domestic product (GDP) figures have been impressive, indicating a resilient economy. Additionally, the ISM services index has shown expansion, employment opportunities remain high, and ADP’s private payrolls report indicates a positive outlook. These indicators contribute to the prevailing market optimism.

The Surprising Rise in Treasury Yields:
One of the primary elements of this market shift is the rise in Treasury yields. While two-year yields have been steadily increasing since early May, what is surprising is the concurrent rise in long-term Treasury yields. This divergence from previous trends suggests that investors are gradually accepting that the Federal Reserve will not be cutting its policy rate anytime soon. The recent acceleration in the rise of long-term rates is unusual, given that inflation expectations have remained relatively stable.

The Paradox of Rising Stock Prices:
This combination of rising yields and stock prices is puzzling. If the economy continues to grow at a robust rate despite the upward pressure on interest rates, the Federal Reserve may need to tighten its policy further to cool the economy. However, the stock market’s upward trajectory contradicts concerns about a potential recession resulting from excessive tightening. Alternatively, it is possible that the Federal Reserve has overestimated the tightness of its policy and may fail to adequately address inflationary pressures. However, inflation expectations, as indicated by breakeven rates, have not increased significantly.

Interpreting the Market Optimism:
The recent rapid increase in long-term real rates suggests that investors have faith in the Federal Reserve’s ability to engineer a soft landing for the economy. This implies that the Fed may be able to achieve lower inflation without triggering a recession. While this belief was previously abstract, it has now been manifested in concrete market prices.

Potential Over-Optimism and Second Thoughts:
However, recent trading activity reflects some second thoughts and a hint of fear regarding a potential Fed-induced recession. Rising rates and falling stock prices during a trading session indicate that investors may be questioning the sustainability of the current market trend. The available historical data on real short-term interest rates, which are currently at their highest level since the 2008 financial crisis, raises concerns about the longevity of positive growth and the effectiveness of monetary policy.

Lessons From the Past and Potential Futures:
Reflecting on the last time two-year interest rates were this high, there are notable similarities to the current situation. While it is crucial to analyze the past to learn from it, comparisons to the past should not be taken as definitive predictions. Each market shift and economic cycle is unique, and it is important to consider the current context and dynamics.

Conclusion:
The recent market shift, characterized by rising long-term Treasury yields and stock prices, along with stable inflation expectations, has caught the attention of investors. This article has explored possible explanations for this transformation and discussed the potential risks and uncertainties. It is essential for investors to carefully navigate these changing market dynamics and consider potential future scenarios to make informed investment decisions.

Summary:
In recent weeks, the markets have experienced a significant shift in trends, with rising long-term Treasury yields and stock prices alongside stable inflation expectations. Economic data, including impressive figures for durable goods and GDP, have contributed to prevailing market optimism. The rise in long-term rates suggests a belief in the Federal Reserve’s ability to achieve a soft landing for the economy. However, recent trading activity reflects some concerns and second thoughts. The current context and dynamics should be carefully considered to navigate these changing market conditions successfully.

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Good morning. This morning’s payroll report has the potential to move markets even more than usual. If it’s as hot as yesterday’s ADP jobs report, the pervasive optimism of the past few weeks could be sucked out of the air. A moderate relationship could keep the good vibes flowing. Deep breaths, everyone. Email us: robert.armstrong@ft.com AND ethan.wu@ft.com.

Something is changed

In the last week or two, something major seems to have happened in the markets. As with any short-term move, the changes could be loud or a temporary byproduct of changing investor positioning. But it seems more significant than that.

The background of the market shift is the economic data which is coming in force. We have discussed the impressive numbers for durable goods and gross domestic product last week. And just yesterday:

• The ISM services index rose to 54 in June, indicating expansion, from a neutral 50 in May, and well above forecasts.

• THE it closes The rate, which had returned to the pre-pandemic average of 2.3 per cent, has returned to 2.6 per cent.

• Employment opportunities have declined, but at a rather secretive pace. They remain over 40% above 2019 levels. There is still a lot of job demand out there.

• ADP’s private payrolls report showed nearly half a million jobs added in June, suggesting that today’s government payroll data could also be interesting (ADP’s numbers are notoriously loud, however).

The crucial shift in the markets is in Treasury yields. Since early May, two-year yields have risen steadily as investors have slowly accepted that the Federal Reserve will not cut its policy rate any time soon. Neither the fixed debt ceiling nor the failure of some regional banks had an appreciable effect on the economy; inflation had come down, but only at a majestic rate; financial markets rose, easing financial conditions. The Fed has no room to cut.

In recent weeks, the rise in two-year yields has only accelerated. What has changed is that long-term Treasury yields have also started to rise, and they are rising very rapidly. See how the pink and blue lines — 10-year and 30-year bonds — snapped together after many weeks of sideways running:

The rise in long-term rates is not in itself surprising. As expectations that the federal funds rate will stay high longer build, it becomes harder for long-term rates to ignore them and stay low. Long rates are just a series of short rates, plus a variable term premium. What AND somewhat surprising is that this coincided with two other events: inflation expectations did not rise and stock prices did.

That’s why this combination is amazing. If growth is still robust after 500 basis points of federal funds rate hikes, the Fed will likely need to do a little more tightening to cool the economy. This, presumably, increases the risk that they screw up timescales and tighten too much, causing a recession. But the rising stock market says that won’t happen.

Alternatively, perhaps the Fed has overestimated how tight its policy is – perhaps the inflation-neutral interest rate is higher than the Fed thinks – and therefore will fail to tighten policy enough, allowing inflation to persist . But low and stable inflation breakevens tell you that that is that won’t happen either. Breakeven inflation rates (Treasury yields minus inflation-linked Treasury yields) have been moving roughly sideways for two years. The recent increase in interest rates is therefore mainly an increase in True interest rates.

The recent rapid rise in long-term real rates is a concrete manifestation of the belief that the Fed will eventually achieve a soft landing: lower inflation without a recession. This belief was abstract, a number in a probability matrix or a graph in a document from a Fed official. As of this month, it’s a concrete fact, written into market prices.

Has the market become too optimistic? Yesterday’s trading was characterized by rising rates and, for a change, falling stock prices. This combination suggests second thoughts, a dash of fear about a Fed-induced recession. And second thoughts are in order. Real short-term interest rates are now higher than they have been since the great financial crisis:

The chart above is enough to make one wonder how long the good growth news will last or whether monetary policy is no longer as effective as before. [Armstrong and Wu]

A good read

Fifteen years ago, the last time two-year interest rates were this high, wrote Unhedged’s friend and rival John Authers this analysis with another friend, Mike Mackenzie. Parts of it came across as uncomfortably prescient about the crisis that was less than a year away. Are there lessons for today? Let’s hope not.

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