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Safety Dance: Bond Rally Puts Pressure on Stocks Ahead of Fed Mtg, Brexit

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June 10, 2016

(NOTE TO READERS: JJ Kinahan is traveling, so the following is a guest Market Update column written by Kevin Hincks, Sr. Specialist, Trader Education Host, and Swim Lessons host. Swim Lessons is trader educational programming, which can be accessed live beginning at 10:30 a.m. CT each trading day from the Support/Chat function within the TD Ameritrade thinkorswim® platform).

(Friday Market Open) Safe havens beckoned Friday as anxiety filtered through both U.S. and overseas markets. A rally in bonds is pushing down yields and appears to be putting pressure on stocks.

The U.S. stock market has climbed a wall of worries in recent weeks back to near its all-time highs. But now the market seems to be taking a pause as investors weigh risk ahead of next week’s Fed meeting and the following week’s vote in Britain (the Brexit vote) on whether to remain in the European Union. The VIX index, which measures market fear, is up sharply, and the dollar is rising against the euro.

Across the world, investors fled to safe havens Friday, and as a result bond yields fell to new troughs in a number of markets. The 10-year German bund yielded as low as 0.023%, surpassing its all-time low of 0.025% hit on Thursday. The yield on the 10-year Japanese government bond hit a fresh low of minus 0.152% on Friday.

The U.S. wasn’t immune, with yields on 10-year U.S. Treasury bonds falling to 1.652%, near the February low. Bond yields move inversely to prices. It appears some investors may be putting their money into U.S. bonds, hoping to get better yields than they can obtain in other markets.

What’s causing this flight to safety? The U.S. bond market has been rallying since last week’s monthly jobs report, which showed just 38,000 jobs created in May and downward revisions to previous months. The report raised concerns about the health of the economy, and caused some re-thinking about when the Fed might raise rates. Additionally, the Fed meeting next week, followed by the scheduled June 23 Brexit vote may have investors worried enough to stay out of more risky bets for the time being.

Another factor likely playing into the bond rally and stock market weakness early Friday was a continued slide in crude oil prices. U.S. oil futures fell below $50, hurt in part by a strong dollar. The dollar’s rally seems to be fueled by the same flight to safety that’s weighing on bond yields. Another “safety” pick, gold, reached three-week highs early Friday.

There isn’t much data on tap today, other than University of Michigan preliminary sentiment (see below). The next key data point comes Tuesday when investors get a look at May retail sales. A 1.3% rise in April retail sales helped fuel impressions of an economic recovery. But what will the May number show?

One other thing to watch for: At 1 p.m. ET Friday, the weekly Baker Hughes U.S. oil rig count is due for release. Last week showed a slight rise in oil rigs, as oil prices continued to climb. With crude now back around the $50 level, more rigs could conceivably come back on line.

S&P 500

FIGURE 1: SUMMER DOLDRUMS?

The S&P 500 (SPX), plotted through Thursday on the TD Ameritrade thinkorswim platform, moved within a tight 10-point range for the day, and hasn't had a more than 20-point separation between daily highs and lows in more than two weeks. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

Down on the Farm: What do soybeans and hogs have to do with the stock market’s recent upward move? Some analysts have said the strong U.S. stock market performance in March and April reflected a relatively weak dollar at the time, and that the rally stalled due to the dollar’s May recovery. Now the dollar is weaker again and earlier this week, stocks neared record highs posted last year. Coincidence? Unlikely. Typically, a weaker dollar helps U.S. exports by making them cheaper for foreign buyers. Which typically helps earnings for U.S. companies that sell a great deal of their products overseas. A weaker dollar also often contributes to rising prices for commodities, which can help underpin shares of U.S. energy and agricultural companies. A lot of focus lately has been on the strong energy sector, but farm economy stocks like Archer Daniels Midland (ADM) and Caterpillar (CAT) are also up in the last few weeks as agricultural commodities like corn, soybeans, and hogs rallied.

VIX Watch: Ever since last Friday’s discouraging monthly jobs report, many investors seem to have been fleeing for safer climes, with assets like bonds, gold and utility stocks receiving much of the benefit. When investors get nervous, as they appear to be this week, another rising indicator can be the Chicago Board Options Exchange’s VIX, a closely-watched gauge of market fear. The VIX had fallen to nine-month lows below 13 earlier this month as stocks surged, but jumped this week to well above 15 by early Friday. But to keep things in perspective, VIX remains pretty subdued, especially compared with levels it reached above 25 during the steep stock market losses of January and February. The all-time VIX average is 15.39, and the index is now above that. It isn’t likely to go down much between now and next week’s Fed meeting and the June 23 Brexit vote.

How’s the Consumer Feeling? The markets may get a better sense of consumer optimism or pessimism later Friday with the release of June consumer sentiment from the University of Michigan. Forecast is for a reading of 95.0, slightly up from the final May number of 94.7. Remember, this is the preliminary reading and it could be revised down the road. The survey has shown a generally upward trend in sentiment ever since the end of the last recession, and had been climbing smartly this year. The question is, will the weak jobs growth the government reported in May factor into Friday’s sentiment number? This is a chance to get an early read on whether that employment report was an outlier or actually a sign of growing problems in the economy.


Good Trading,
Kevin

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