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Market Eyeing Afternoon Treasury Auction As 10-Year Yield Falls Below 1.6%

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One of the market themes that’s been emerging as the vaccination rollout continues and economic optimism improves is that investors have been switching out of growth stocks and into names that stand to benefit as the economy recovers.

While that’s beneficial for the likes of the Industrials and Materials sectors, it also hinges on a linchpin of modern trade: supply chains. One of the big lessons learned from the past year is that they matter, and shouldn’t be taken for granted.

The Interplay Between Supply Chains And Markets

Remember when the world brought their offices home? We all got a lesson in supply chain dynamics as manufacturers struggled to keep up with the shift in toilet paper demand from the industrial to the in-home roll. That same type of supply chain disruption has played out in numerous industries in the past year.

For example, for years, it’s made sense for semiconductors to be manufactured abroad, but then after a hiccup or two, possible shortages lead to concerns on not only the corporate front but also that of national security. That same quest for efficiency has meant bigger barges floating through canals, but when one turns sideways and gets stuck, the entire system gets bogged down. At the moment, there’s a massive container ship blocking the Suez Canal and a big chunk of global trade—disrupting up to $10 billion per day according to some estimates.

Flashing back to the early days of the pandemic we saw weakness in the just-in-time supply chain model as factories in China had to shut down. More recently, worries have surfaced about the frosty relationship between China and the United States, which involves a trade partnership between the world’s largest economies.

As we’ve seen in recent manufacturing data, supply chain snarls have increased prices that producers are passing along to their customers. In recent days, inflationary concerns have affected expectations in the stock and bond markets.

And now we’re trying to roll out vaccines and make them available to billions of people worldwide, while also trying to manage the changing logistics of a pandemic. Considering the tenuous nature of supply chains, a few fits and starts are perhaps to be expected.

It’s another reminder that, as we digest the news of the day/week/month, markets are interlinked—across asset classes as well as geographies.

Labor Market Situation Improves

In economic news this morning, weekly jobless claims numbers were better than expected, coming in at 684,000, well under a Briefing.com consensus that had expected a print of 710,000.

The weekly unemployment report has gained new importance during the pandemic as it provides a more regular look at the labor market than the government’s more in-depth monthly employment situation report.

But the stronger-than-forecast showing this morning didn’t do much initially to lift equity index futures. It seems that the negative sentiment from yesterday’s really ugly close may be finding its way into this morning’s trade.

In general, it seems like investors are uncertain, which can lead to selling. Apparently, they’re still trying to figure things out as the narrative shifts from stay-at-home trades and big growth stocks to cyclical names as the economy re-opens.

Capitulating Capital

After trying valiantly, the S&P 500 Index (SPX) and Dow Jones Industrial Average ($DJI) on Wednesday couldn’t shake the recent pessimism about the global economy that also sent stocks lower in the previous session.

For much of the day, the SPX and $DJI were solidly in the green, but a late selloff took both into negative territory as selling in major tech-related names accelerated and some reopening stocks ended on the back foot.

News that the Centers for Disease Control and Prevention won’t drop a restrictive, coronavirus-related sailing order appears to have struck another downer note in a week that has seen worries ratchet up as the pandemic worsens in parts of the globe.

As might be expected on news like that, cruise line shares fell, and it appears that airline names declined in sympathy. Both types of companies are highly dependent on travel and tourism, sectors that have been crushed as governments have put up restrictions to try to stem the tide of COVID-19.

The pressure on travel-related stocks combined with more selling in big-tech related companies such as Apple Inc (NASDAQ: AAPL), Facebook, Inc. (NASDAQ: FB), Netflix Inc (NASDAQ: NFLX), Amazon.com, Inc. (NASDAQ: AMZN), and Tesla Inc (NASDAQ: TSLA) to weigh on the market. Even the chip industry, which had been helped by encouraging turnaround plans from struggling Intel (INTC), couldn’t hold on to gains.

Economic Optimism Not Enough

Aside from the travel stocks, it seems that there was some buying in companies that stand to do better as the economy reopens. The Industrials and Materials sectors regained some ground from the previous session. Energy was by far the best performing sector of the day, although much of those gains seemed to be tied to rising oil prices on news of a grounded tanker blocking the Suez Canal. (See more on the ship issue below.)

There may have been some support for cyclical stocks from upbeat comments on the economy from Treasury Secretary Janet Yellen and Federal Reserve Chair Jerome Powell in their second day of congressional testimony. Still, their testimony didn’t contain any big surprises.

Earlier pro-cyclical developments—such as INTC’s plans to build two new factories, news that more states are expanding vaccine eligibility, and strong purchasing manager data from the U.S., Germany, and France—that had helped stocks earlier in the day faded as the selling in tech-related names increased.

It seems that the repricing of mega cap growth shares is continuing. Those companies helped lead the market into a bull rally that turned one year old this week. But their shine has been dulled as the need for their relative safety has diminished apace with the economic recovery. Rising interest rates have also called into question their valuations based on expected future earnings.

The Auctioneer’s Gavel

Speaking of rising rates, it was last month at about this time that the rising-rates narrative jumped to page one, after a tepid auction of 7-year Treasury notes triggered a selloff in bonds that spilled over into the equity markets. (Actually, dealers and analysts used adjectives far beyond “tepid,” such as “disastrous” and “awful”).

So you might want to keep an ear to the market this afternoon. At 1:00 pm ET the Treasury Department plans to auction off another $62 billion in 7-year notes. Strong demand could help settle the bond market, but there’s also the possibility of another tepid auction (or whatever adjective you prefer). And remember: All the stimulus that’s making its way through the system needs to be paid for one way or another—through tax revenue or fresh borrowing.

While the Fed has reiterated its commitment to picking up the slack through its bond-buying programs, questions remain regarding how much will need to be absorbed by the central bank versus other bond buyers—and at what equilibrium price will these bonds change hands. But we head into this afternoon’s auction with the 10-year yield continuing to pull back from high last week’s high of 1.75%. We begin Thursday with the 10-year falling below 1.6%.

philadelphia semiconductor index
philadelphia semiconductor index

CHART OF THE DAY: CRUDE’S COMEBACK. After dipping below its 50-period exponential moving average (EMA—blue line) on Tuesday, crude oil futures (/CL—candlestick) made up the losses yesterday. /CL is now testing the 50 EMA support of $58.94. The Suez Canal misadventure likely played a role, but the $58.94 is still a key level to watch. Thursday begins with crude drifting back below the $60 level. Will the 50 EMA support level hold? Data source: CME Group. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Another Inflation Alarm Bell: Fresh manufacturing data for the U.S. showed improvement in factory activity, but it also showed steep inflationary pressure from the sector. The flash U.S. manufacturing purchasing manager’s index (PMI) from IHS Markit (NYSE: INFO) rose to a two month high of 59 in March as new business accelerated at the sharpest pace since June 2014. But supplier shortages and input delays caused manufacturing firms to register the fastest rise in input costs in a decade, and charge inflation rose at the fastest clip on record as firms partially passed on greater input prices, IHS Markit said. The data firm’s services PMI showed supply chain issues led to input price inflation rising at the sharpest pace since that data began being collected in late 2009.

The I Word: The inflation data from the IHS Markit report perhaps puts an increased spotlight on personal consumption price index numbers scheduled to be released later this week. The core PCE price index on Friday is expected to show a 0.1% month-on-month gain in February, according to a Briefing.com consensus. That’s pretty tame, especially when you consider the previous month’s reading put the year-on-year increase at just 1.5%, well under the Fed’s 2% target. But as the recent surge in the benchmark 10-year Treasury yield showed, there’s been increasing worry that inflation could rise to problematic levels if stimulus measures and the vaccine rollout boost demand to a level where supply can’t keep up because of supply chain disruptions. Keep in mind, though, that it’s possible that higher inflation could be—in the words of Fed chair Jay Powell, “transitory”—and not a big enough problem that would cause the Fed to raise rates sooner than expected. With these issues bouncing around the collective mind of the market, stocks could be especially sensitive if Friday’s data shows a bigger-than-expected move higher in inflation.

Not Shipshape: There’s a phrase in economics that says “a rising tide lifts all boats.” The idea is that greater gross domestic product, for example, positively benefits all participants in the economy to one degree or another. On Wednesday, many were hoping the tide (and lots of tugboats) would lift one very large boat that was causing a traffic jam in one of the world’s most economically important waterways. The Ever Given, a container ship longer than the Eiffel Tower is tall, became wedged across the Suez Canal after running aground during high winds. That created traffic jams on either end of the waterway that handles around 12% of global trade and offers the shortest sea route between Europe and Asia. As a slew of tugboats worked to free the huge vessel, oil prices rose sharply, with international benchmark crude more than erasing steep losses from the previous session and the U.S. benchmark contract rising back above the $60-barrel mark. The gains in oil prices helped boost the Energy sector to the best performing spot in the SPX on Wednesday.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

Photo by Chris Barbalis on Unsplash

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