In the “traditional” free market (before the Federal Reserve began massive monetary stimulus to suppress interest rates after 2000), investors brought a certain amount of capital to the markets, which they divided between stocks and bonds.
It was a zero-sum game. If investors put more money into stocks (usually when the economy was growing) they would put less into bonds. Putting less money into bonds caused their prices to drop, which caused interest rates to rise. Interest rates also rose during expansions because companies borrowed more money for productive capital investments.
During economic contractions, stocks fell. Investors shifted toward a risk-off trade. They sold stocks (driving stock prices lower) and bought safe bonds, such as Treasuries. This caused bond prices to rise and their interest rates to fall.
Investors could also sell their financial assets and move into cash. This would be like a retreating tide, draining money from the markets and causing the prices of all assets to drop together. (Each asset individually affected differently, depending on sales.)
Mike Shedlock (mishedlo, the original founder of this board) has just posted an interesting idea.
“Over the past five decades, only when the 10-year T-note yield plunged 135 basis points (on average) did the S&P 500 manage to make a bottom."
This makes sense. A fall in the 10-year T-note (10YT) yield is equivalent to investors saying, “I’m giving up on stocks. I can’t stand the uncertainty anymore. I’m buying risk-free Treasuries.”
Mish posts charts showing that stocks peak and begin to fall about the same time that Treasury yields peak and begin to fall. Stock prices don’t bottom until Treasury yields bottom. At that point, investors start shifting money from Treasuries back to stocks. Then Treasury prices fall and the yields start to rise again.
The 10YT peaked at the beginning of May. It’s beginning to fall.
**Bonds’ Descent Stalls Amid Stock Turmoil**
**Treasury yields stabilize as investors worry about an economic slowdown and seek safe assets**
**May 23, 2022**
**On Monday, futures bets showed traders assigning a roughly 83% probability that the Fed will close 2022 with its [overnight] rate target between 2.5% and 3%...**
“Bonds’ descent” is equivalent to saying “rising yields.”
If the Fed raises the overnight fed funds rate to 3% and the 10YT yield is 3% the yield curve would be flat. If the 10YT yield falls, the yield curve would be negative – usually a harbinger of recession in several months.
This gives METARs a useful signal!
If this isn’t noise and 10YT yield begins to fall in earnest, we will watch it closely. Only after the 10YT yield bottoms and begins to rise will the stock market have bottomed.
The Fed could manipulate this by selling some of their huge book of Treasury and mortgage bonds. Will they? Who knows?