From Steep Yield Curve to Tax Breaks: What caused the 2021 and 2016 sell-offs, and can we predict how the market will bounce back?
The markets appear to be rebounding this week after a few weeks of selling off, especially in tech and growth stocks. Our research shows many similarities between the last weeks’ sell-off and the sell-off in 2016. While they both have different catalysts causing them, there are reasons to believe that the outcome will be similar.
Catalysts for 2021 sell-off: Inflation expectations and SLR
The yield curve has been steepening since November 2020, in the hopes of both an effective and efficient vaccine rollout and stronger economic growth. So then, why are yields rising and bonds selling off (which is causing the yields to rise)? There are two main reasons for that: inflation expectations and the supplementary leverage ratio (or SLR for short). The pressure that inflation causes on the fixed income market is nothing new and has been discussed in previous reports.
So let’s focus on the ladder today: the SLR
SLR is a leverage banking requirement which came into place after the 2008 crash. It requires banks to maintain a certain level of capital for their leverage exposure. What has been happening in recent months is that due to the massive QE, and now the fiscal policy stimulus of $1.9T which will find its way into the banking system, banks need to put up more capital to maintain the suggested SLR. Always remember that a bank’s balance sheet is the opposite of a company’s balance sheet and customer deposits act as a liability and not as an asset. Since banks have been anticipating more than expected deposits due to fiscal stimulus, they have had no choice but to offload some Treasuries to maintain the SLR.
2016 tech sell-off: Trump’s tax cuts
We saw a similar impact on tech stocks in late 2016 after Trump was elected and the market started to price in his promised Tax Act. Tech stocks, which were mostly unprofitable at the time, sold off because they could not take advantage of this anticipated tax break.
However, three months later, the Nasdaq finished 13 percent higher.
At Peak Capital Trading, as the fixed income market starts to settle, we are expecting another rally in the tech sector.
As always, please do not hesitate to reach out if you have any questions.
Ardi