Second Half Kickoff—A dichotomy between rates and equities
Equities rose another 3% during July, driven by expectations of a Fed pause and lower inflation.
The equity upswing is at odds with U.S. 10 Yr. Treasury rates, which increased during July. One would expect rates to be falling in anticipation of lower inflation, or equities to be falling as rates move higher for the second month. Alas, not everything makes sense in the short term.
For rates, fears of greater dollar volume of issuance and higher growth rates drove the 12 basis point increase to 3.96% in July.
Despite this increase in rates, equities continue to believe in a soft landing and better future growth. Additionally, algorithmic traders (who are completely insensitive to fundamentals and valuation) continue to pressure volatility which in turn drives up equity pricing. These strategies work really well…until they don’t. Recall “Volmageddon” in February of 2018 when the VIX (index of volatility) rose from 17 to 37 in one day and the major indices dropped approximately 2.5% as the VeloctiyShare Daily Inverse VIX Short Term ETN went bust, taking $2 billion of investor assets with it.
That’s not to say this will happen again. However, the odds of upside vs. downside are becoming increasingly asymmetric given how one-sided this trade has become. It’s a bit like the game Jenga when too many blocks are on one side: The tower may stay up and it is possible to correct the issue, but you don’t want to be holding the last block.
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