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The Tell: A calmer bond market is helping drive stocks higher around the world

Waning volatility in the U.S. bond market has helped spur a rally in stock markets around the world, according to the latest research note from Deutsche Bank’s Jim Reid.

Reid, head of thematic research at DB, pointed out that bond-market volatility, as measured by the ICE BofA MOVE Index, appears to have peaked in October (see chart), just as expectations for the terminal fed-funds rate — the level at which the Federal Reserve is expected to pause its most aggressive cycle of rate hikes since the 1980s — stabilized around 5%, where they remain.

DEUTSCHE BANK

See: ‘You can be invested in fixed-income again,’ bond investors say, even before the Fed stops hiking rates

Over the past year, fluctuations in bond yields have been one of the most important factors influencing stocks, as MarketWatch has reported. Bond yields move inversely to bond prices.

So long as bond markets remain calm, Reid expects stocks will continue to rally. It’s one reason why he and his team are still “tactically bullish” on equities, although they expect the market’s mood to sour later this year.

The 10-year Treasury yield
TMUBMUSD10Y,
3.538%

has fallen by roughly 50 basis points since the end of October as inflation has pulled back from peak levels and as the Fed has signaled plans to hike interest rates by smaller increments.

While the S&P 500
SPX,
-0.28%

has risen more than 11% since rates volatility peaked on Oct. 12, according to FactSet data, European and Asian equity indexes have rallied by an even greater margin when translated into U.S. dollar terms, according to data cited by Reid.

The Stoxx Europe 600 Banks Index
SX7P,
-0.17%
,
which includes shares of some of the largest eurozone banks, is in the lead, having gained more than 40% in the months since rates volatility peaked, according to Reid’s data. The FTSE MIB
I945,
+0.31%
,
a benchmark for large Italian stocks, and Germany’s DAX 40
DAX,
+0.11%
,
seen as the blue-chip gauge for German companies, also posted double-digit gains in dollar terms. The euro
EURUSD,
-0.28%

also has strengthened against the dollar since October.

DEUTSCHE BANK

According to Reid, investors the world over owe their good fortune in part to growing certainty that the fed-funds rate isn’t expected to go much higher than 5%.

“…[A]fter 9 months of high uncertainty about where the Fed’s terminal rate would top out, markets started to coalesce around a peak of 5% in October. That coincided with commentary at the time suggesting [Fed officials] were comfortable downshifting the pace of hikes, as they went onto do in December. This was also around the point where the inflation data started to turn, with markets increasingly hopeful that the worst was over,” he said.

Senior Fed officials have signaled that the Fed will likely opt for smaller rate hikes when it meets in February and March, after raising its policy rate by 50 basis points at its December meeting, and by 75 basis points in four prior meetings. Projections released by the central bank in December suggested that the Fed likely won’t cut interest rates until 2024.

Fed funds futures traders, meanwhile, expect the first rate cut will arrive sooner than that. The CME’s FedWatch tool shows traders expect the first cut to arrive in the fourth quarter of 2023.

Many on Wall Street are concerned that last year’s market chaos could come roaring back later this year if the hoped-for Fed pivot doesn’t arrive as quickly as investors expect.

The Fed hiked its benchmark target rate from a 0%-0.25% range in March to 4.25%-4.50% in December, the most aggressive pace of rate hikes since at least the 1980s, with an eye to taming the worst inflation in decades. Inflation has receded in recent months, according to the consumer-price index, a closely watched gauge of consumer prices.

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