“What Pandemic?”

By Ian Lyngen of BMO Capital Markets

3-Handle Again

Global equities continue to perform well as reopening optimism remains the primary driver and S&P 500 futures breached the 200-day moving-average to trade >3000 for the first time since early-March. Trading off the same underlying impulse, the Treasury market has seen yields edge higher; albeit within a definable range – one which has kept 10-year rates at ~70 bp and squarely locked into the 54 bp to 78 bp zone. We’ve been on about these specific trading parameters for several weeks at this point and maintain that the longer the levels holds, the more difficult a meaningful challenge becomes. The persistence of the range despite the ability of the S&P 500 to reverse nearly ~70% of the March crash is very telling and presents an uncomfortable scenario in which ‘the facts have changed more than the prices’ – which is a classic precursor to a breakout.

The performance of risk assets implies any such breakout would be a bond-bearish event; although we’re far less convinced on the inevitability of this outcome. In fact, the bid for stocks and reluctance of US rates to venture to a higher plateau are based on a key underlying assumption; the Fed will continue to use its balance sheet in support of easier conditions for the foreseeable future and expand further when the time comes. There is a collective understanding that such a time will eventually come; after all, the ranks of those who believe in a V-shaped recovery are dwindling to the point that this degree of optimism is the exception, not the norm.

Nonetheless, stocks >3000 marks an important milestone – recall that July 2019 was the first time the S&P 500 broke into the land of the 3-handle and it wasn’t until Q4 of last year when 2-handles became a thing of the past… well, until 2020.

What pandemic?

The achievement is rather staggering when put in the context of Q2 real GDP estimates in the -30.5% (NY Fed) to -41.9% (Atlanta Fed) tracking range. Whether the realized contraction of the US economy is simply dismissed as priced-in or if it shocks risk assets off their upward trajectory will largely be a function of investors’ interpretation of the Fed’s reaction-function to additional weakness as the post-pandemic landscape comes into focus. Powell & Co. haven’t come close to exhausting their toolbox, therefore our assumption is that there will be greater policy accommodation in the offing; level-specific forward guidance followed by yield curve caps. This is fairly consensus at this point; although the estimates of the timing vary. The FOMC has a strong incentive to keeping something in reserve once V-shape recovery ambitions are fully abandoned.

More immediately germane to trading in the Treasury market will be this morning’s round of economic data – the most meaningful of which being the 10am release of Conference Board confidence and the new home sales series. If the confidence reads from Germany overnight are any indication, the lows are in for the pandemic inspired rebasing of the global economic outlook. While this doesn’t imply the depths of the recession are as of yet known, the willingness of investors to move forward remain notable. In this regard, the consensus -23.4% drop in new home sales during the month of April speaks the relevance of April in marking the bottom for the data – a key underlying assumption supporting the summer-bounce scenario. As has been the case throughout the majority of the pandemic, the incoming reports have proven to be far less tradable events than the outright numbers would imply.

Our take remains that the magnitude of the contraction is so extreme as to truly lack any context and therefore the mid-March repricing stands as the benchmark for and adjustment to the outlook going forward. While this diverges materially from any attempt on the part of the market to correlate a specific level of output or inflation expectations (to say nothing of PE multiples) to an outright yield level or equity valuation, it does confirm an appropriate degree of relevance to the extremes of the moves during March.

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