Inside Markets — Momentum Reversal

Ten-year bond yields have started a short-term mean reversion trade with the benchmark rate lifting from key support levels. As we noted yesterday, bond prices are overbought with yields overshooting their implied fair value. A reversion to the mean could take 10-year yields to ~4.45%, which looks like a reasonable level to consider adding bond duration.

Higher bond yields by themselves shouldn’t create a near-term headwind for equity markets, but higher bond volatility would. Bond volatility, as measured by the MOVE Index, has ticked higher the last two weeks, but remains well below levels that could spill into equity markets.  Equity market volatility, as measured by the VIX Index, is at very low levels and shouldn’t be a headwind either.  The momentum reversal we identified back on 11/28 could extend for another week before it fades. Momentum reversals occur every year at this time and are generally nothing more than a distraction. Next week’s CPI report, FOMC meeting and retail sales report will be important inputs for the near-term outlook. A continuation of the soft landing narrative would still leave markets with late-cycle dynamics. In our view, further upside in equity markets requires a cyclical recovery, which depends on policy accommodation that usually follows a correction in asset values.