For fitness freaks, the 12-minute Cooper test has a special significance in assessing aerobic fitness.
On Friday, the US stock markets saw a Cooper-test equivalent as the US Federal Reserve Chairman Jerome Powell addressed the gathering at the keenly-watched Jackson Hole Symposium.
While Powell acknowledged that pricing pressures -- or inflation -- had eased compared to a year ago, he continued to stress the need for a restrictive monetary policy, not ruling out further rate hikes to nail down the 2% inflation target firmly to the floorboard. Powell was, almost immediately, followed by European Central Bank (ECB) President Christine Lagarde, who reiterated the 2% inflation target and her intention to set rates 'at sufficiently restrictive levels for as long as necessary.'
Powell's 12-minute speech put currencies, bond yields and equities on a severe endurance test. The three major US indexes, which first seemed uneasy ahead of Powell's speech, opened higher, got whipsawed, gained ground in the afternoon trade and eventually ended higher on Friday. At one point, the Dow Jones Industrial Average, the S&P 500 and the Nasdaq Composite were below water level, though not by much.
However, by the closing bell, they all ended in the green -- gaining 0.7-0.9% for the day.
At the same time, there was action in another corner -- bond markets.
Yields on the 10-year US treasury bonds have been rising higher and higher in recent days. The yield on the 10-year treasury bond touched 4.366%, a level last seen in 2007. As any book on finance would tell you, when the yields rise, prices crash, hurting bond investors.
On Friday, US treasury bond yields too went through mixed emotions, first falling during Powell's speech, then rebounding closer to recent highs and eventually declining to close at 4.227%. Likewise, the 2-year treasury yield, a barometer for expectations about the Fed Funds Rate, too was up at 5.1% from about 5% earlier, as Powell's speech confirmed, more than once, that the fed funds rate may remain elevated for a while.
If the 10-year US yield rose about 40 bps this month to 4.30%, the Indian benchmark 10-year bond yield gained only about 5 bps. Reuters did some math and found that the spread between the two narrowed to around 290 bps, a level similar to June 2009.
Anyway, the market reaction so far has been nothing like the fireworks seen after the Jackson Hole speech of 2022, when the Dow plummeted by 1,000 points. Markets had corrected last year after Powell adopted a harsher-than-expected tone in the speech and said the central bank would do everything necessary to bring price stability and rein in inflation.
Nevertheless, how Asian indices will react to the speech is not yet known. In fact, most Asian markets, including Seoul, Tokyo, Shanghai and Hong Kong, betrayed some trepidation ahead of Powell’s speech and closed in the red on Friday. Whether they will take their cues on Monday from the seemingly optimistic view of events taken by the US markets remains to be seen.
IMPACT ON EMERGING MARKETS
Rising bond yields deliver a one-two punch on emerging markets like India.
One, as yields climb, it's bad news for the stock markets as money gets reallocated to the bond market simply because of the rising returns on offer. Moreover, higher interest rates also dampen corporate earnings, hurting stock valuations further.
This also plays out across boundaries: When interest rates rise, foreign investors waste no time abandoning risky assets like equities to take sanctuary in the US treasury's white-hot rates, leading to capital flight.
Indeed, tracking the sharp rise in bond yields in the US over the last several weeks, the Nifty 50 has fallen 1.45% in the last one month alone. Foreign investors sold Indian equities worth some Rs 13,000 crore during this period. The trend was evident on Friday too, when foreign investors sold Rs 4,600 crore ahead of Powell's speech.
Worryingly for equity market valuations, some believe a higher-yield regime is here to stay. Such a prospect will be ruinous for emerging markets, whose charms lose much of their magic in front of the allure of rising, zero-risk US bond yields.
US Treasury yields are considered rates of risk-free return, given that the risk of the US defaulting on treasury bonds are considered close to zero.
As a result, higher yields are bad news for equities, which unlike bonds aren't backed by the government. So when bonds offer higher returns, investors tend to naturally take out their dollars from stock holdings and channel them into safer avenues.
Meanwhile, the outlook for US monetary policy remains ambiguous with no clear decisive sign of further hikes, or stay on hold. In the last 12 meetings, the Fed raised rates 11 times taking borrowing costs to a 22-year-high of 5.25-5.50% range.
It is in this context that the 'optimists' in equity markets were looking for clues in Powell’s Jackson Hole speech as to when he would start reversing the rate hikes.
However, what they got was the opposite, with Powell saying the central bank was prepared to raise rates further if necessary, and intends to hold policy at a restrictive level until it is confident that inflation is moving substantially down.
Going by the markets’ reaction on Friday, however, Wall Street seems to be betting on another rate pause in September. Will pundits retain the optimism in the coming days? Only time will tell.