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  • The Nasdaq 100 was the worst performing major US index on Wednesday, as Big Tech was sold amid rising yields.
  • Rotation into economic “reopening” stocks exacerbated this trend, while bad data weighed on the whole market.
  • Fed Chair Powell’s remarks on Thursday will be closely followed regarding how the bank could counter rising yields.

The “reopening” trade was on full display in US equity markets on Wednesday, with investors selling stocks that have benefitted from lockdown, including Big Tech names such as Microsoft (-%), Apple (-%) and Amazon (-%), in favour of stocks that are more likely to benefit from economic reopening. The S&P 500 industrial sector hit intra-day record highs.

Note that recent announcements out of major US states in the last few days (the Governor of Texas pushing for a full reopening and both San Francisco and New York easing restrictions) are helping this trend, as likely also is commentary from US President Joe Biden in recent days, in which he has said he expects all US adults to be offered their first vaccination by the end of May.

Further exacerbating the selling pressure in tech names or, more broadly, in growth stocks (with high price-to-earnings ratios) was a rise in long-term US bond yields; 10-year yields were up around 5bps on the day and 30-year yields were up about 4bps. The S&P 500 growth index dropped 2.5% on the day, while the S&P 500 value index was flat.

Downside in large tech and high P/E ratio names unsurprisingly weighed most heavily on the Nasdaq 100 index, which sold off throughout the session, dropping 2.9% to the 12,600s. The S&P 500 was also dragged 1.3% lower into the low 3800s, with key support at the 3800 mark looming. The Dow (which is less weighted towards tech) held up better, dropping 0.4%. The CBOE Volatility Index (or VIX) rose 2.4 points to just above 26.50 and is now just over 2 points away from February highs.

Downbeat US ISM Services PMI and ADP national employment data exacerbated selling pressure on Wednesday. Fed speak and the release of the Fed’s Beige Book were largely ignored; the later stated that the US economic recovery continued at a modest pace at the start of 2021, with businesses optimistic about the months to come and demand for housing remaining robust, although the improvement in the labour market was slow.

Downbeat US data

February ISM Services PMI survey was underwhelming, with the headline index dropping to 55.3 versus expectations it would remain steady at 58.7. Note; that is still a historically strong number, but just not what markets have come accustomed to as of late. The subindices also showed weakness, with Business Activity dropping to 55.5 from 59.9 in January, Employment dropping to 52.7 from 55.2 in January and New Orders dropped nearly 10 points to 51.9 from 61.8. Capital Economics think the weakness represents severe winter weather conditions seen across the country last month. Meanwhile, Prices Paid shot higher to 71.8 from 64.2 amid supply shortages, a jump which Capital Economics thinks may foreshadow an increase in Core PCE to about 2.4% within the next few months.

Wednesday also saw the release of ADP’s estimate of the number of jobs added to the US economy in February; their estimate suggests the economy gained 117K jobs, lower than expectations for their estimate to show a job gain of 177K jobs. Capital Economics note that this data was a disappointment given that “the drop-off in coronavirus case numbers and the resulting lifting of containment measures should be giving the economy a bigger shot in the arm”. The economic consultancy continues that “the disappointing ADP figure presents a clear downside risk to our otherwise above-consensus estimate that non-farm payrolls increased by 500,000 last month”, but they caveat that “given the ADP’s patchy correlation with the official employment data and the strength of the high-frequency data, we are happy to stick with that estimate”.

Potential Fed response to rising bond yields

Fed speak on Wednesday has for the most part not revealed anything new in terms of how Fed officials view the US economy, but Fed members have been talking much more openly about the kinds of policies they would like to see employed in order to curb rising bond yields if things got “out of control”. Operation twist (where the Fed maintains the monthly pace of treasury purchases but increases the weighted average maturity of its bond purchases) and yield curve control (where the Fed sets a yield target and buys bonds in whatever quantity is necessary to keep yields below this level) are both being talked about. It seems as though Fed members would need to see a significant amount of further upside in US bond yields in order to justify these policies, however, hence why desks are calling for more Fed action only if 10-year yields rally to the 1.75%-2.0% region.

In terms of what the above means for stocks; the best scenario for stocks would be if bond yields decided by themselves that they no longer want to rise anymore, thus taking the pressure off of the shoulders of the Fed to intervene. As the US economic outlook improves, however, this seems unlikely. Thus, stocks could be in for more pain if yields continue to surge. Then how interventionist the Fed is will become important; the more eager they are to counter any tightening of monetary conditions, the better for stocks.

Fed Chair Jerome Powell will be speaking to the WSJ on Thursday, with his remarks scheduled for release at 17:05GMT and traders will be on the lookout for more information regarding all of the topics discussed above.