Most days are just pages on the calendar – today matters more than others for investors. We believe the bond market is sending equity investors a very powerful signal: Today’s price action is an interest rate explanation point that the global economy is recovering, that the trade talk resolution between the US & China is real, and as a result growth and inflation spirits are reviving swiftly. Bond market traders are sending a confirming signal that the stock market surge to new highs is valid. The charts below show the green light signals for equity investors shooting up from the bond market:
Figure 1: The yield on the 10-Year U.S. Treasury has broken an important intermediate downtrend that started in late 2018. We believe this is significant as the surge to 1.95% today is confirming that bond investors believe the economy is likely to improve. Rates began to fall in the summer of 2018 as investors thought the Fed was too hawkish – this led to lower longer term rates, and a stock market sell-off in the last months of 2018. Since that time, the Fed has taken actions to promote growth. The 10-year Treasury Yield break-out says bond traders are now believers.
Figure 2: The slope of the US Treasury Yield Curve from T-bills to 30-Year Treasuries is breaking out to new highs for 2019. At the end of August, the yield curve between T-bills and 30-Year Treasuries was actually inverted. On August 30th a 3-month T-bill yielded 1.98% and a 30-Year Treasury yielded 1.96%. So, the curve slope was -2 basis points. The inverted yield curve caused worries about growth. Since that time, the Fed has worked hard to signal accommodation and a commitment to rising inflation. Thanks to Fed rate cuts, the yield on 3-month T-bills has fallen 50 basis points to 1.5%. The yield on 30-year Treasuries has risen over 40 basis points to 2.4%. As a result, the yield curve is now positive with a slope of +90ish basis points. We believe this likely means the Treasury market is pricing that the Fed will succeed in raising inflation expectations (rising growth + rising inflation expectations = steeper curve). This steepening is likely to continue.
Figure 3: The rise in rates is global. Even yields on 10-year German government bunds are rising sharply. Many investors have viewed the Eurozone economy as dead. As the chart on bund yields shows, fixed income traders are changing their mind quickly. Rates that were sharply negative on bunds are on the verge of turning positive.
Figure 4. Stocks are breaking out to new highs. The S&P has broken out of a very large trading range. While technicals should always be viewed with healthy skepticism, the dark arts of technical analysis suggest this rally could last a while. This would be consistent with the playbook I have referenced in prior commentaries: namely that the best example from the past to inform this particular moment in market history is 1998. The late 1990’s witnessed an EM shock, Fed easing, a bear steepener, and a surge in stocks, all framed by impeachment proceedings.
Figure 5: The TIPS market may be confirming this party may last. Inflation breakevens are rising again. We will track this development as there are resistance levels to monitor.
Figure 1: 10-Year Treasury
Source: Bloomberg accessed 11/7/19.
Figure 2: 3 Month/30 Year Treasury Slope
Source: Bloomberg accessed 11/7/19.
Figure 3: 10-Year German Bund
Source: Bloomberg accessed 11/7/19.
Figure 4: S&P 500 Index
Source: Bloomberg accessed 11/7/19.
Figure 5: 10-Year TIPS
Source: Bloomberg accessed 11/7/19.
Jonathan E. Lewis
Chief Investment Officer
Index Definitions
The S&P 500 is a stock market index that tracks the stocks of 500 large-cap U.S. companies.
