In this business, they teach you early that the bond market is smart money. If that’s true, equity investors may want to start paying closer attention.
Of course, we don’t really know whether that statement is true or if it’s just another piece of market lore passed from trader to trader over the years. At a minimum, though, it’s fair to say the bond market is sending a very clear message to Federal Reserve Chairman Warsh:
“Don’t even think about cutting.”
S&P 500 and NASDAQ 100
If all you did was look at these two charts, you would be hard‑pressed to find a problem. Both indices continue to look like healthy consolidations above rising 60‑week moving averages.
That is perfectly normal behavior.
Source: Optuma
Two‑Year Yield and Fed Funds
The bond market is giving Chairman Warsh a very clear signal: do not cut.
In fact, I would argue the message is even stronger than that. The bond market appears to be saying that hikes are in order. The two‑year yield sits at 4.56%, nearly 100 basis points above the Effective Fed Funds Rate.
To be clear, nobody expects a cut. In fact, as I write this on Monday morning before the market opens, Bloomberg is assigning roughly an 86% probability to a hike this week.
Source: Optuma
Aggregate Bonds
There are not many words needed here.
Aggregate bonds have fallen out of bed and remain well below their 40‑week moving average.
Source: Optuma
Investment Grade Corporate Bonds
Investment grade corporate bonds are not doing any better. The group continues to crater below a declining 27‑week moving average.
This is a trend we watch very closely.
Source: Optuma
This Is Why You Should Care
This is a chart we have been using for more than four years, and we will continue to hammer home the point.
All of the above matters because if the bond market really is the "smart money," you need to understand that stocks and bonds are positively correlated at both the one‑year and five‑year lookback periods.
In other words, if bonds are sending a warning, equities may not be insulated from it.
Source: Optuma
Final Thoughts
Bonds are sending a clear message that rates should be higher. The question is what will stocks do from here. If recent correlations hold, there are increased odds that stocks follow bonds lower.
