Interesting to watch the Treasury market turn weaker today even as losses in stocks accelerate. I’ve been feeling for a while that the classic negative correlation between Treasury and stock prices will break down, at least on a day-by-day basis.
1) Any significant rise in Treasury prices will force consumer borrowing rates higher. There isn’t much room for further spread tightening, especially in mortgages. So higher Treasuries probably means lower stocks.
2) Foreign buying is critical if Treasury yields are to remain low. Foreigners are more likely to buy when the dollar looks stable. The dollar is more likely to be stable if the economic picture is decent, and thus stocks advancing.
3) The stock market would probably welcome additional quantitative easing from the Fed. Based on yesterday’s minutes, I expect any additional QE to be aimed squarely at the Treasury market. So Treasuries and stocks would both rally.
For what its worth, yesterday’s minutes also indicated that the Fed doesn’t have any particular 10-year yield in mind to defend. Or at least, if they do, that number is much higher than where we are. If the Fed cared about 3% or even 3.25%, the talk of expanding QE would have been more urgent.
Could you argue that allowing the 10-year to move from 2.50% to 3.25% is a de facto tightening of monetary policy? Maybe not, because most non-Treasury borrowing rates are lower today than 2 months ago, and thus you can’t claim that credit availability has declined. However, I certainly think if they allow the 10-year to move much past 3.25%, they you will start seeing yields away from Treasuries back up as well. That will indicate tighter policy, which would be bearish for the economy.
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