On Monday, I started with a review of the S&P from various points of view (flipping the chart instead of changing the time frame). The market was arguing for a rally and with a few words from President Trump premarket, the S&P screamed, and then dumped. Yesterday’s note shifted gears looking at ETFs, commodities and the banks. Today we continue this view of a bounce and then fall for the equity markets, through the lens of the rate markets.

What’s interesting about the current rate markets is that they are on balance flat over the past 9 months. The 10 year is slightly lower and the 2 year is basically flat, seesawing back and forth on Fed cuts and possible Fed hikes.

10 Year Note…a 2004 Echo

On Monday, I mentioned the S&P 500 was following the 2010 playbook – rally short term and selloff into summer. 2010 had a flash crash that set much of the selling into motion but another period that resembles 2010 was 2004, minus the flash crash. The S&P fell during that period as well but eventually launched higher into year end (like 2010). Well the 10 year yield is closely following 2004 (correlation .79)! 2004 saw rates climb and then fall through the summer, as market weakness saw buyers come into bonds. If 2004 is in the cards for rates, this argues that perhaps this war is near its end and the “flash crash” scenario is not being baked in by investors but rather a more modest retrenchment in stocks?

So What Does the 2 Year Say?

Over the past week, since the energy markets have done their thing and skyrocketed, short rates, namely the SOFR ones that I follow, have seen them move to a more normal curve with short rates lower than longer rates. The analog below shows three periods – 2019, 1982 & 2010 (The 2-year’s 200-day pattern correlates at 0.83 with 2010). Again, there is 2010 as part of this mix. 2010 saw a climb in the 2 year, a retrenchment and then it fell after another climb about 100 days from now as the surge off the 2009 low seemed to peter out and the Fed was worried about growth, taking rate hikes off the table (leaving rates at zero and adding levels of QE).

But the Long Term Chart Tells a Different Story

So we have 2010’s and 2004’s all around the storyline here but this chart is not following either of these paths. The turn higher in the 2 year this month, with only a few days left, broke firmly over the 13 month MA. Whipsaws do happen, so this could unwind next month, but if this continues to climb, this rate will have turned higher on a key moving average and a key momentum variable I look at – Both were trending lower since the fall of 2023, when this monster rally in assets began.

So Next Month Is Key…

With the rising 2 year yield, I believe the next month will be key for this storyline. If the market sells the 2 year yield next month and flips that chart lower (buying short paper), as the inflation story goes away (presumably because energy prices fell), then that will tie to the chart below which shows that most energy spikes are followed by a fall in the 2 year yields since the 1980s. But what if that doesn’t happen and rates continue to climb?

Watch This Chart!

This is the chart of the 2 year yield vs excess reserves of banks. Remember what I said on Monday…when money is falling, conditions tighten. Over the past few weeks, after a period of tightening, as this war has evolved, reserves have jumped and the 2 year has followed. When the economy weakens, we tend to see excess reserves rise, at least since 2008, as the Fed panics and pumps money into the system (reserves benefit). The market is perhaps taking the 2 year higher because the Fed is pushing via reserves AND the market remembers the Fed’s moves in the 1970s – easing into a rising inflation story!

So I See 2010 but Remember Monday and 2008

2010 is still my baseline for the markets. Bounce higher but then fall lower. If crude backs off ahead of the summer driving season, the economy will not suffer as much. If crude does not and the war drags on, and the Fed chooses to ignore inflation, we could see a bout of nasty data on the inflation front, which puts a more dramatic selloff on the table after a bounce. The action over the past week argues to me that the market is worried about the 1970s playing out.

It’s worth noting that gold’s 200-day analog matches 1977 and 1979 – precisely the periods where the Fed declared victory on inflation too early. The gold market is pricing 1970s risk. It comes down to the 2-year. If it continues climbing next month, 2010 is off the table and we’re pricing something worse.

To finish the week up, I will share how to play this more specifically! Stay tuned.

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