Morning Notes — Favorable Risk-Reward

Inflation breakeven yields tend to lead equities and Fed expectations during periods of elevated inflation. The historical collinearity of these cross markets was broken from late February through early May after 10-year breakeven yields pushed through key resistance at ~280bps following the Russian invasion.  During this period, higher 10-year inflation breakeven yields drove hawkish Fed rhetoric and higher Fed rate hike expectations, but also higher long-dated bond yields.  In functioning markets, higher Fed rate expectations should lead to lower long-dated bond yields.  The irrational short-term relationship pushed bond market volatility higher, taking equity market volatility along for the ride.  Fortunately, the collinearity between these markets began to improve following a late-April peak at ~303bps and rational relationships were completely restored on May 9 when breakeven yields crossed back below ~280bps. We see a very favorable risk/reward for the SPX as long as 10-year inflation breakeven yields remain under 283bps (now ~274bps).  We also note a fading volatility tailwind as the VIX descends from a peak of 34.75 to 24.20 today.