Trading Day: Bonds play the blues

By Jamie McGeever

ORLANDO, Florida, Aug 17 (Reuters) - Long-dated government bond yields ‌around the world rose on ​Monday to levels not ​seen in decades. This weighed on stocks, which were also pressured by deepening skepticism around a U.S.-Iran peace deal and oil prices rising to a six-week high.

In my column today, I look at how the Fed could bring inflation back down to target. Chair Kevin Warsh has indicated a smaller Fed ‌balance sheet and an AI-productivity boom would be useful tools. But neither is a substitute for the bluntest, but most effective, instrument in ⁠the Fed's toolkit — interest rate hikes.

If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.

1. China's recovery sputters as consumption, output lose steam

2. ‌Japan Q2 growth misses forecasts on weaker spending, ‌investment

3. EXCLUSIVE-Anthropic IPO valuation hinges on $190-200 billion 2028 revenue forecast, sources say

4. Big investors hunt for tomorrow's AI winners as capex angst fades

5. China surprises oil markets again with a return to stockpiling in July: Russell

Today's Key Market Moves

• STOCKS: Japan's Nikkei closes at 6-week high, UK falls for sixth day, Europe little changed. Big three U.S. indices ​down 0.3-0.5%.

• SECTORS/SHARES: All bar one — energy — of the 11 sectors on the S&P 500 fall. Comms services, consumer staples -1.5%, energy +1%. Carvana -7%, Sandisk +9%.

• FX: Dollar eases slightly, AUD and NZD biggest G10 gainers +0.3%, BRL among biggest EM gainers +0.5%.

• BONDS: 10-yr JGB yield 2.93%, highest since 1996. France 10y yield highest since 2009, Bund yield highest since 2011. 30-year ⁠U.S. yield above 5.30%, highest since 2007; 30-year TIPS yield 3.09%, highest since 2008.

• COMMODITIES/METALS: Oil +3%, Brent back above $90/bbl. Gold +1%, above $4,400/oz.

Today's Talking Points:

Long Bond Shiver

Long-dated bonds around the world are under the cosh again. From the U.S. to France, from Germany ​to Japan, yields on government debt with maturities of 10 years and beyond spiked to fresh multi-year or multi-decade highs on Monday.

The pressure is coming from all sides — oil back above $90 a barrel on evaporating hopes of a U.S.-Iran peace deal; worries over a more ​aggressive rate-hike cycle in Japan; fiscal fears in France and the U.S., where the federal debt is ‌about to top $40 trillion; soaring government interest payments; sluggish demand at government debt auctions. How long before other parts of the financial market universe start to crack too?

Global Growth Shakes

Global stock markets and corporate earnings may be purring along nicely, but the global economy's performance is less ⁠convincing. July economic indicators from China and Q2 Japanese GDP data show Asia's two largest economies aren't firing on all cylinders. The figures from Beijing were particularly worrying — retail sales, business investment, industrial production all missed economists' forecasts, once again dousing hopes that domestic demand is finally emerging from its post-pandemic slump.

If you take into account the sluggish 1.5% annualized U.S. GDP growth in the second quarter, that's three of ⁠the world's largest economies under-performing. Policymakers will want to see how Q3 pans out, but more incoming data like this will likely cast doubt on the wisdom of rate hikes in the U.S. and ​Japan, and accelerate calls for more stimulus in China.

AI Funding (In)Visibility

A Wall Street Journal report on U.S. hyperscalers' off-balance-sheet AI spending commitments is a reminder of how high the profitability bar is in the AI arms race for these firms. The report says Big Tech's AI spending may be $3 trillion higher than it seems. If so, does that alter how investors should view these behemoths, and the AI story ‌in general?

AI-related spending is already expected to be off the charts. Morgan Stanley reckons the four largest hyperscalers (Microsoft, Alphabet, Amazon, and Meta) will increase spending next year by 57% on this year, with a view to generating 25%+ returns on invested capital. But it is taking ‌longer for that capex deployment to bear fruit, resulting in gloomier near-term free cash flow estimates. A wider financing gap next year should lead to even more debt issuance.

What could move markets tomorrow?

• Developments in ⁠the Middle East

• UK labor market: unemployment rate, earnings (June); payrolls (July)

• Germany ZEW ‌index (August)

• U.S. industrial production (July)

• U.S. import and export prices (July)

Want ​to receive Trading Day in your inbox every weekday morning? Sign up for my newsletter here. Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.

(Reporting by Jamie McGeever; ‌Editing by Nia Williams)

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