The bear has dozed off… nap or hibernation?

Recession fears have curbed the concomitant decline in stocks and bonds that developed during the first half of 2022. After several weeks of declines that sent the S&P 500 Index into bear market territory, stocks are showing a tangible rebound, aided by a decline in dollar yields and a reassessment of the outlook for monetary tightening. Like the rebound in March and again at the end of May, last week’s rally in equities is not well supported and could be a bear market rally.

A sustainable recovery in equities and bond markets will inevitably require a significant and lasting decline in inflation, which would allow the Fed and other Western central banks to conduct more friendly monetary policies. The materialization of this scenario requires a stabilization of commodity prices, especially energy prices, which have largely contributed to the surge in inflation. In this respect, the drop in of prices observed last week is a welcome development, provided that it is lasting.

The economic news in the US is marked by a sharp decline in the PMIs. The gauge for the manufacturing sector fell from 57 in May to 52.4 in June, while the index for services dropped from 53.6 to 51.6. Despite a modest recovery, the level of initial jobless claims still reflects a tight labor market, even though a few iconic companies, such as Tesla, have announced plans to reduce their workforces. In the residential real estate market, the median price of existing home sales reached a new high, but transaction volumes continue to decline in response to rising mortgage interest rates (now near 6% for a 30-year fixed rate loan) and rising construction costs for new homes.

The U.S. dollar yield curve has fallen significantly from the levels seen in mid-June. The yield on the 10-year T-Note fell back to around 3.15% after briefly approaching 3.5%. The decline in the yield on the 2-year T-Note from 3.4% to 3.1% reflects a downward revision of the outlook for interest rate hikes through 2024 (which does not rule out a hike near or above 3.5 % before the Fed reverses course, as happened in 1994/95 and which Fed Governor James Bullard aptly mentioned last week).
In Europe, the decline in the euro interest rate structure is even more pronounced. The yield on the German Bund has fallen by almost 40 basis points from 1.8% to 1.4% (before rebounding to around 1.5%). This decline is supported by numerous symptoms of slowing activity, such as the drop in PMIs (52 after 58.4 for the manufacturing sector, 51.3 after 53.7 for services) and Christine Lagarde’s reaffirmation that the ECB will only raise its key interest rate by 0.25% in July.

In the credit market, the widening of risk premia contradicts the renewed optimism expressed on Wall Street. The excess yields or spreads associated with corporate bonds are now close to 170 basis points on average for the “Investment Grade” segment and 580 basis points in the “High Yield” segment, both of which have been weakened by the emergence of recessionary risks that raise doubts about the sustainability of the rebound in equities that occurred last week.