U.S. stocks finally stopped falling yesterday following data indicating a slowdown in job growth, which alleviated concerns about the Federal Reserve's monetary policy direction and put a halt to the recent surge in bond yields.
Still, strategists at Barclays warn that the bond market is likely to continue selling off, which will likely send stocks further lower.
“We do not see a clear catalyst to stem the bleeding,” the strategists wrote in a note.
Barclays economists still expect the Fed to hike at least once. Hence, they were of the view that the bond markets were pricing in far too many cuts in 2024. As a result, the rate strategists continuously urged Barclays’ clients to stay short bonds.
“But after the 10y reached 4.6%, we turned neutral on duration… Bonds were not compellingly cheap, but finally seemed fairly priced.”
The strategists highlight two key factors why bonds are falling: 1) Higher for longer regime adopted by the Fed, and 2) Rising term premia due to the worsening in the U.S. fiscal situation.
They are adamant that the Fed won’t step in to save the bond market.
“In our view, there is little chance that the Fed will suddenly stop QT, and even less of a chance that it will re-start QE. Moreover, it would be counterproductive. Monetary policy would suddenly turn far less restrictive, while the economy is still growing above trend and inflation is far from 2% – a recipe for higher yields,” they added.
“The only way the Fed could help longer yields is by hiking so aggressively that markets are convinced a recession is imminent and rush to buy longer rates. But that is extremely unlikely as well. The Fed is likely simply to stay the course.”
A situation where mortgage rates are at nearly 8% and a U.S. long bond at almost 5% might weaken the economy considerably, and therefore provide relief for the bond market, although Barclays strategists say this won’t happen “quickly enough.”
All these factors led the strategists to believe that only risk assets moving sharply lower could help the bond market at the moment. They argue that “the magnitude of the bond sell-off has been so stunning that stocks are arguably more expensive than a month ago, from a valuation standpoint.”
“If risk assets fall sharply in the coming weeks, bonds will likely benefit from the portfolio effect,” they noted.
Barclays equity strategists have long argued that the fair value of the S&P 500 index is still below its current spot level. These forecasts were made when bond yields were at lower levels, which suggests that there is still room for equities to adjust to current market conditions.
“We believe that the eventual path to bonds' stabilizing lies through a further re-pricing lower of risk assets. Absent that, there is no sustained bond stabilization and, given how risk assets are finally responding to bonds, no stabilization in risk assets, either. We believe stocks have substantial room to re-price lower before bonds stabilize,” the strategists concluded.