May 31, 2023
The 2-year Treasury yield is reversing from technical price support in the 4.51%-4.59% range. The 10-year note has reversed from similar support near 3.85%, and the 30-year bond fades from price support at 4.00%. We’d expect 4% to keep a lid on yields in the months ahead. All tenors are now oversold and reversing despite what should be a challenging supply outlook. Look for lower yields in the near-term with possibly one final push to these levels later during the month. The basic message is that bond yields have peaked, and we’re in favor of extending duration where appropriate.
Fed pivot: Fed officials continue to use hawkish rhetoric with rising expectations for another rate hike in June. That could happen, but the set-up from the 5/10 year yield curve should redirect market attention to an eventual pivot within months. The 5/10 curve inversion has widened out to -12bp after briefly crossing into positive territory last month. Technical support for the 5/10 curve inversion sits in the -14bp to -17bp range. We expect that level to hold and for the curve to flip back into positive territory within 1-2 months. A 5/10 curve spread greater than +18bp indicates a change in trend, and we’re using it as our early indicator for a Fed pivot. We expect the curve will remain in positive territory this time around and expect the +18 spread threshold will be attained this summer.
SPX: Convincing the Fed to pivot will likely require a period of acute economic pain and sharply lower asset prices. The narrow leadership and crowding in mega-cap names that we’ve recently witnessed is typical at the end of a cycle. It’s a defensive, ‘flight to quality’ dynamic that’s often followed by a ‘flight to cash.’ The entire process may be more shallow than past cycles, but the recovery will be led by deep cyclicals like commodities, Materials and Financials.