It’s no secret that Treasury yields seem to be calling the tune for the stock market.
Soaring yields got most of the blame for a selloff that saw the S&P 500 slip more than 10% from its late July high into correction territory at the end of last month.
Last week was turnabout. Yields on 10-year Treasury notes
and 30-year Treasury bonds
saw their biggest drop since March. Stocks soared, with the S&P 500
Dow Jones Industrial Average
and Nasdaq Composite
logging their biggest weekly gains of 2023.
The S&P 500 ended Friday at 4,358.34.
Investors can debate whether the top is in for yields, which move opposite to Treasury prices. But the lingering question is whether a definitive top in yields will be a definitive signal that stocks can resume their 2023 rally.
Like most things market-related, it all depends on the context.
Or as analysts at U.K.-based Matrix Trade put in a Sunday note: Yields “could top for a variety of reasons but not all of them would be good for stocks.”
A bullish scenario for stocks would see the economy stays strong as inflation drops back to levels that would eventually allow the Federal Reserve to cut interest rates without a 1970s-style secondary wave of inflation, they said. They don’t see that scenario as likely, “but without a spike higher in unemployment, it could still happen,” they wrote.
A recession, on the other hand, could see yields and stocks move lower together as they did in 2000-2002 and 2007-2009.
Economists have been flummoxed by the resilient economy, they noted, with the vast majority having called for a 2023 recession at the beginning of the year, only to change their tune in July or August around when the S&P 500 logged its high for the year.
Part of the difficulty is the “variable timing” of the signal provided by the inversion of the yield curve, they said. An inverted curve, in which short-dated yields exceed long-dated yields, is seen as a reliable recession precursor, but with uncertain timing.
The Matrix Trade analysts said the signal can be fine-tuned by combining it with unemployment claims. They expect first-time claims to break above the 250,000 threshold, at which point “there is likely no turning back.”
The number of Americans who applied for first-time unemployment benefits last week rose by 5,000 to a seven-week high of 217,000 in the week ending Oct. 28, the Labor Department reported on Nov. 2, suggesting some softening in a sturdy U.S. labor market.
While the fate of the stock market isn’t so clear, it will be a little easier to know when yields have topped out, the analysts argued.
The 4.33%-4.43% area acts as a major inflection point for the 10-year Treasury note, they said. As long as it holds, the 10-year yield can make further highs above 5%, they said; if it breaks, “we will have to conclude the rally is complete.”
The Matrix analysts said a broader correction would put a fall back to a 2.5% to 3% for the 10-year yield as the initial target. If that’s the case, it implies the economy would come under pressure as it seems unlikely yields would fall that low without a recession, the analysts said.
“Putting this together with stocks suggests the current euphoric rally will not continue into the next bull market and 4,103 will be challenged again early next year,” they said.