October 24, 2023
Elevated Treasury supply and waning demand remain primary drivers of the higher bond yield environment. Two-year yields are higher into today’s large $51B auction that will require some concessions to get done. Tomorrow’s $52B five-year auction and Thursday’s $38B auction will likely keep near-term upward pressure on these tenors. Ten-year Treasury prices flashed bullish momentum divergence signals last Friday on the approach to 5%, and we see technical room for yields to fall to ~4.75% in this window.
In our opinion, an equity bull market requires a cyclical recovery, which usually requires monetary accommodation and expanding money supply. We have neither at the moment and getting there likely requires a period of economic pain. A cyclical recovery that follows a soft landing is possible, but the sequence from a recession-driven bear market to policy accommodation is far more likely. The inverted 2/10 yield curve is now 16 months old with a perfect track record predicting recession-driven bear markets 19-24 months after the initial inversion. The 5/10 spread is the other segment of the yield curve with predictive powers as a sufficiently positive 5/10 slope tends to precede a Fed pivot by 1-2 months. A sufficiently positive slope is one that breaks above its downtrend, which in this case lines up with +19bp.
Cyclical equity indices like the Russell 2000 (RTY) are down ~16% from their July 31 close, while the SPX is down ~8% and the NDX ~7%. The RTY broke key support earlier this month after bearish distribution patterns formed over the summer. Other cyclical proxies like the EuroStoxx 50 (SX5E), copper/gold ratio and equal-weight S&P 500 (SPW) have seen similar breaks following distribution patterns. Markets tend to lead data by several months and the underperformance in cyclical benchmarks is signaling an economic slowdown is just ahead.