• Stock markets get kneecapped by relentless rally in US yields

• Gold and oil prices lose steam amid lack of geopolitical escalation 

• Euro/dollar stable ahead of key events, yen ignores BoJ reports

Stocks get bruised 

The shockwaves from the seismic rally in US bond yields have started to cause tremors in the stock market. Shares on Wall Street fell sharply last week as a mixture of geopolitical concerns and the meteoric rise in US yields dampened risk appetite, sending investors scrambling to reduce their exposure to riskier assets.

With the US government boosting its debt issuance to fund enormous budget deficits and a streak of encouraging data releases that have seen Fed officials preach a ‘higher for longer’ regime on rates, the demand-supply dynamics in bond markets have shifted in favor of higher yields. The yield on 10-year notes hit 5% last week for the first time since 2007. 

When investors can earn a 5% annual return on safe assets such as government bonds, they are less likely to take chances on riskier plays, which helps explain why stock markets have been feeling the blues lately. Beyond providing an attractive alternative to equities, higher bond yields also make it more costly for businesses to take on debt, limiting the scope for expansion and ultimately earnings growth.

Overall, the risks surrounding stock markets seem tilted to the downside. The S&P 500 is still trading for 18 times forward earnings, under the analyst assumption that earnings will grow 12% next year. Hence, valuation multiples have not truly compressed despite the ferocious spike in yields, while the projected growth in earnings seems overoptimistic heading into a global slowdown. The risk is that reality doesn’t live up to these rosy expectations.

The earnings season will kick into high gear this week with Microsoft and Google reporting tomorrow, ahead of Meta Platforms on Wednesday and Amazon on Thursday.

Gold and oil prices take a breather

Geopolitical worries have been front and center this month. The hostilities in the Middle East came out of the blue to rattle investors, generating an influx of demand for safe havens such as gold and commodities like crude oil that could see their supply flows disrupted if tensions in the region escalate.

What’s striking is that although gold prices have acted as the barometer for geopolitical tensions lately, other classic safe haven plays such as bonds and the Japanese yen have been almost immune, barely responding to the conflict. In other words, geopolitical stress in the markets has been contained to a handful of instruments.

As for gold, it appears vulnerable to a downside correction. Bullion has risen around 9% in two trading weeks as safe-haven demand overpowered the selling pressure exerted by soaring real yields. However, markets can learn to live with geopolitical risks as we saw after Ukraine’s invasion. If there is no serious escalation and safe haven demand dries up, gold might be forced to realign with its gloomy fundamentals.

FX market quiet ahead of key events

A sense of calm has descended upon the FX market on Monday, with most currency pairs trading in relatively narrow ranges and without any clear direction. Of course, this might only be the calm before the storm as a series of exciting events lie ahead to fuel volatility.

Euro/dollar will be in the eye of the hurricane with the latest round of business surveys tomorrow, ahead of the European Central Bank decision and the quarterly US GDP report on Thursday.

Finally, the yen continues to trade near the 150 mark against the dollar, unable to capitalize on media reports that the Bank of Japan might consider some further policy tweaks at its meeting next week. It seems the yen has bigger problems on its plate, as it grapples with the non-stop rally in US yields and elevated oil prices.