One of my favorite big-picture indicators is the spread between 10-year and 2-year yields. Members have seen this chart many times. It shows that previous sharp expansions of the spread — not the state of being inverted — signaled the coming equity crashes.Looking at the components separately, we can see exactly what happens when the spread widens. In the 2000-2003 and 2007-2009 crashes, the 2-YR drops sharply and the 10-YR follows. In the 2011 and 2015-2016 corrections, the 10-YR saw most of the action — primarily because the 2-YR didn’t have much room to fall.Both have now broken above long term trend lines — the implication being that yields have broken out and have much further to go. I believe this is an erroneous conclusion.
First, note prices (ZN) have had a nice bounce off a long-term channel bottom. We wrote about this in April [Bonds: A Buying Opportunity] and have since seen ZN pop back above both medium-term (purple) and longer-term (red) trend lines. Yesterday, it tagged our second upside target.The subsequent reversal has been impressive. And, to be sure, oil and gas have reversed nicely off recent highs — mitigating some of the inflation pressure that sent rates soaring.
RB reached our initial downside target from May 21 [see: Once More With Feeling] yesterday, but both it and CL have a little further to go. Unless the BLS butchers the energy component of May’s CPI, we’re certainly not out of the inflation woods just yet.
Bears would do well to keep an eye on USDJPY, which tagged our 1108.23 target yesterday. The BoJ-IMES conference is underway. USDJPY breakouts, together with VIX smackdowns, have ruined many a correction.
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