With all the heavy breathing regarding the yield curve at the moment, let’s not forget that the flattening has been all about the historic jump in front-end rates. Never before have we priced so much so quickly. From a market determined interest rate perspective, rates are now already priced for 2.40% Fed Funds at year end. While the Fed is playing catch-up with actual monetary policy, the tightening have already happened from an economic perspective. What in the past took many months, or even years, has now occurred in a few short months.
I am now very focused on the long end. What do 10’s and 30’s do now? When those yields start to drop it will be a good indication that front-end rates are starting to have an effect on the economy/inflation. There is a good chance that that starts in the next few months. It will also herald the end of the tightening cycle.
That that will mean for stocks however is not so simple. A meaningful turning point in 10-year yields could occur because: 1) Stocks have sold off to a point that effectively triggers the “Fed put” (stocks fall first as they did in ‘87 and arguably ‘18), 2) Falling yields reflect a weakening economy and impending recession (2000 and 2007), 3) A fall in inflation expectations means lower yields are appropriate and stocks, having been held back by rising yields and the fear of inflation, start to rally (early ‘95). It is conceivable, given the current backdrop, that the market cycles through a couple of these scenarios before settling on the final outcome. Watch 10’s and 30’s for a sign that change is afoot.
