Breadth divergence is a troubling sign for the stock market

Treasury yields retrace a portion of latest dive as Fed official sounds warning

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Bond yields rose on Monday as a Fed official called for caution on optmism that inflation may have peaked.

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

    rose by 5.9 basis points to 4.382%. Yields move in the opposite direction to prices.

  • The yield on the 10-year Treasury

    climbed 6.9 basis points to 3.888%.

  • The yield on the 30-year Treasury

    added 1.8 basis points to 4.075%.

What’s driving markets

U.S. government bonds returned to action for the first time since the sharp rally on Thursday following cooler-than-expected inflation data. The market was closed on Friday for Veterans Day.

“U.S. yields saw a massive decline ranking in the bottom 1% largest downside moves in the past 50-years. Analysis by our data scientist, Matt Cerminaro, shows yield declines of this magnitude portend further declines in rates 6M and 12M forward. In other words, chances are rising the highs for the 2Y and 10Y yield are in,” said Tom Lee, head of research at Fundstrat, referring to last Thursday’s trading.

However, after diving 33 basis points in the previous session, the biggest daily fall since March 2009, the 10-year Treasury yield is retracing a small portion of that move after Federal Reserve Governor Christopher Waller said on Sunday that investors should not get overexcited by one data point.

“The market seems to have gotten way out in front over this one CPI report. Everybody should just take a deep breath, calm down. We’ve got a ways to go, ” Waller said.

Markets are pricing in an 85% probability that the Fed will raise interest rates by another 50 basis points to a range of 4.25% to 4.50% after its meeting on December 14th, according to the CME FedWatch tool. The central bank is expected to take its Fed funds rate target to 4.9% by June 2023.

What are analysts saying

Ian Shepherdson, chief economist at Pantheon Macroeconomics, said much of the sharp slowing in consumer CPI looked sustainable including rents, though he noted that Fed chair Jay Powell seemed to be saying at his November 3 press conference that lower CPI prints are neither a necessary nor sufficient condition for a pivot to a slower pace of rate increases.

“But they can’t hurt, and a similar reading in November—the data will be released before the December FOMC meeting—would increase the pressure on the Fed to hike by no more than 50bp at that meeting,” said Shepherdson.

“The market is now pricing in 50bp, with investors reluctant, so far, to take a more aggressive stance. But the risks are asymmetric; we see little chance of markets going back to expecting 75bp, but if the data cooperate, 25bp is possible,” Shepherdson concluded.

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