Tenuous Relief Rally
November 1, 2023
The pullback in bond yields keeps a tenuous relief rally in the conversation, but the move falls short of signaling a short-term trend reversal. Ten-year yields have pulled back to 4.80% with a sustained close below 4.73% building confidence around a near-term top in yields. We become even more confident at levels below 4.48%, but continue to see that as a bearish outcome for stocks. Stocks and bonds can become positively correlated in the short-term, but the two assets have a negative long-term correlation. Equity markets are welcoming the pullback in bond yields for now, but an eventual break in this correlation will likely be bearish for stocks. An inverted yield curve has a perfect track record in predicting recession-driven bear markets 19-24 months after the initial inversion. The current inversion has been in place for 17 months. A bull market in the current environment requires a cyclical recovery, which almost always requires monetary accommodation and expanding money supply. The Fed may be done with rate hikes, but their commitment to shrinking the balance sheet means that liquidity will continue to contract at an unprecedented pace. The Fed will likely need to be forced into policy accommodation by acute economic pain and lower asset prices. The good news is that equities will rise ahead of policy accommodation with a positive inflection in the 5/10 curve as our early indicator. The 5/10 curve has steepened to +7bp from a record trough of -36bp. A 5/10 spread north of +19bp looks like the inflection point, but that could be months away.