Fed credibility concerns are 'overstated,' says Frank Flight
Secretary of the Treasury Scott Bessent may get what he wants after all, says Citadel Securities.
A big test is coming for the artificial-intelligence trade with Nvidia earnings after the close.
Bonds, meanwhile, are still getting plenty of attention after respected investor Stanley Druckenmiller joined a crowd in warning that Secretary of the Treasury Scott Bessent's plan to buy back longer-term Treasury bonds to lower yields won't achieve its goal.
Our call of the day from Citadel Securities' macro strategist Frank Flight, however, argues longer-term yields are headed lower over the next few months. He said a sustained bond rally could even force a so-called short squeeze, in which those who have bet on bond prices falling are forced to buy them back, pushing prices up even higher.
Bond yields have been rising this summer amid worries about inflation, notably energy prices, and increased debt supply from governments and top technology companies. Higher yields are worrying as they can raise borrowing costs for companies and the government, and pressure the economy.
Yields have eased a bit since Bessent's statement last week. While longer-term Treasury yields were creeping up on Wednesday, the 30-year yield BX:TMUBMUSD30Y is well down from the 2007-era highs reached last week.
Laying out his call, Flight told clients in a note published on Tuesday that for starters, "incremental central bank credibility concerns are overstated."
The strategist sent the market abuzz last month when he predicted - wrongly as it turns out - that the Federal Reserve would hike interest rates. He said the market would have probably rewarded an interest-rate hike with lower long-end yields and a reduction in term premium - the extra return investors demand for holding long-term bonds.
While that didn't happen and the Dow slumped 1,150 points for its worst day in 15 months, data between the June meeting to present has shown some cooling in employment and inflation, meaning the Fed was right to hold off, he said.
Even if a September rate hike doesn't materialize, investors can't keep demanding higher yields on concerns the Fed hasn't got inflation under control, the strategist argued.
He offered proof via a chart of Citadel's "Inflation Credibility Indicator," which measures a piece or pieces of data relative to history, for several market metrics, including inflation swaps, the dollar, gold, oil and both short- and long-term interest rates. It gave a Z-score.
A score above 1.0 indicates extreme market stress, while below -1.0, as seen currently, indicates lower stress. His chart shows pressure has eased since earlier in the summer, meaning investors have struggled to keep demanding a premium for a perceived lack of Fed credibility.
Flight also looked at positioning across trend-following funds. He said those investors are placing historically high bets, based on recent history, that bond yields will keep rising.
That means the balance of risks going forward is uneven. With so many of those investors betting on higher long-term yields, there probably aren't many more left who can keep selling should bonds weaken further, he said. However, he warned that a more "sustained rally" in bonds would "force a more meaningful unwind" of existing bearish bets, giving long-term bond prices a boost.
The third and final part of Flight's argument is based on a macroeconomic framework from Citadel that gauges market expectations for economic growth and Fed interest rates. He said when growth expectations are elevated and the outlook for interest rates is more benign, such as now, bonds tend to rally in the following months. "Across 64 comparable episodes since 2003, yields subsequently fall by an average 12 basis points over 60 days, 25 basis points over 120 days with yields lower in 71% of cases," Flight said.
The markets
U.S. stock futures (ES00) (YM00) (NQ00) are flat and oil (CL.1) (BRN00) is down.
Key asset performance Last 5d 1m YTD 1y S&P 500 7677.28 -0.19% 3.35% 12.15% 18.73% Nasdaq Composite 26,151.30 -0.53% 5.12% 12.52% 21.38% 10-year Treasury 4.65 0.00 -3.40 47.80 41.10 Gold 4680.4 2.18% 15.12% 8.04% 35.59% Oil 79.98 -5.24% -5.46% 39.31% 25.24% Data: MarketWatch. Treasury yields change expressed in basis points
The buzz
Nvidia (NVDA) will report results after the close, with expectations high. Options markets, meanwhile, are betting on a quiet investor reaction.
Salesforce (CRM), Synopsys $(SNPS)$, CrowdStrike (CRWD) and HP $(HPQ)$ will also report late.
Intuit stock $(INTU)$ is slumping after the tax software group's guidance seemed to disappoint investors.
Weighing on oil prices, Oman and Iran discussed "a joint temporary navigational corridor" in the Strait of Hormuz.
The Fed's preferred personal consumption expenditure price index for July is due at 8:30 a.m. Eastern, along with durable-goods orders and the second estimate of second-quarter gross domestic product growth.
Results from a $70 billion auction of 5-year notes are due to be announced.
I walked 500 miles on the Camino de Santiago to find what comes next
The chart
Morgan Stanley
The National Oceanic and Atmospheric Administration recently said there's a 95% chance the current El Niño weather event would be the strongest since 1950. The Morgan Stanley chart shows "the first indications of market transmission in selected commodities and company disclosures." As strategists explained in a note, El Niño is expected to peak in the fourth quarter of this year, but persist into the first half of next year, affecting into North Hemisphere planting and two Southern Hemisphere crop cycles. "The risk is consecutive-season of abnormal weather conditions," said the strategists.
Top tickers
These were the top-searched tickers on MarketWatch as of 6 a.m.:
Ticker Security name NVDA Nvidia SPCX SpaceX MU Micron AMD Advanced Micro Devices TSM Taiwan Semiconductor Manufacturing META Meta AAPL Apple INTC Intel GME GameStop SNDK Sandisk
Thousands flock to a small Spanish town to fling tomatoes.
-Barbara Kollmeyer