Breadth divergence is a troubling sign for the stock market

Treasury yields edge higher, with 2-year rate back above 3%, ahead of Fed decision this week

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U.S. bond yields rose Monday, with the 2-year rate back above 3%, as investors sold off Treasurys amid cautious trading ahead of the Federal Reserve’s next rate decision this week.

What’s happening
  • The yield on the 2-year Treasury

    rose to 3.035% from 2.989% late Friday. Yields move in the opposite direction to prices.

  • The yield on the 10-year Treasury

    advanced to 2.819% versus 2.781% on Friday.

  • The yield on the 30-year Treasury

    rose to 3.048% from 2.996% Friday afternoon.

What’s driving markets

Yields moved higher, reversing a small portion of the sharp drop seen over the past few sessions, when recession concerns appeared to trump inflation fears. In Monday’s only U.S. data release, the Chicago Fed National Activity Index came in unchanged at minus 0.19 in June.

On Thursday and Friday, the benchmark 10-year Treasury yield had fallen 25.4 basis points for the biggest two-day decline since the start of March, according to Dow Jones data.

Meanwhile, the 10-year to 2-year spread of minus 17.5 basis points as of Monday morning means the yield remains notably inverted, potentially signaling a looming economic downturn.

The Federal Reserve will deliver its latest monetary policy decision on Wednesday. Markets are pricing in a likelihood that the Fed will raise interest rates by another 75 basis points to a range of 2.25% to 2.5% after its meeting on July 27th.

The central bank is expected to take its borrowing costs to a cycle peak between 3.25% and 3.5% by February 2023, according to fed funds futures trades shown in the CME FedWatch Tool. That so-called terminal rate is earlier and lower than seen of late and suggests the markets think the Fed’s recent rate rises are already damping activity.

Overseas, signs of economic stress in Europe are building. Business confidence in Germany worsened sharply in July as firms turned more pessimistic due to rising energy costs and the threat of gas shortages.

The Ifo business-climate index declined to 88.6 points in July from a revised figure of 92.2 points in June, data from the Ifo Institute showed Monday. This is the lowest value since June 2020. However, 10-year German bund yields

were more in thrall to their U.S. peers and rose to 1.064%.

What analysts are saying

“Recession fears are riding high after preliminary July PMI surveys out Friday suggest that the Eurozone economy is on the brink of recession and that the U.S. services sector is in contraction,” said strategists at Saxo Bank in a note to clients. “U.S. Treasury yields tumbled all along the yield curve late last week as the market lowers the anticipated peak fed-funds rate and sees easing inflation,” Saxo added.

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