Bonds rallied in a big way today with intraday lows of 2.885% in 10yr yields. There was also a prominent sell-off in stocks, begging the conclusion that this was a classic “stock lever” move. But that’s not exactly right, and it’s easy to see why.
To be fair to stocks, they are still somewhat involved in the other series of events that precipitated this rally in bonds. When they topped out on Monday morning, it was at levels just below the last major top (itself just below the previous top). Taken together, it looks like stocks are having a very tough time bouncing back after the heavy losses of the past few months.
Combine the stock hesitation with Fed speakers who are increasingly calling economic momentum into question and its enough for financial markets to start guarding against a shift by moving investment strategies away from risk. One of the most obvious trades in the bond market has been “curve flattening.” Specifically, this means shorter and longer-term yields are moving closer together. The most widely-followed portion of the curve is that which lies between 2yr and 10yr Treasury yields (it’s so widely-followed that the 2s/10s curve is synonymous with “the yield curve” according to most market watchers).
The curve matched record lows for this economic cycle on Friday and then broke to new lows yesterday. After holding flat at those levels overnight, domestic traders punched-in for the day ready to keep the curve trades coming. This is what drove the early gains in longer term bonds. More than half the rally was intact by the time stocks began tanking around noon, but indeed, that did help bonds extend the gains to the day’s best levels.
Long story short, markets are worried the Fed is right in its assessment that economy may weaken in 2019 and that rates may not need to rise much more. The warning shots for the shift in the economic cycle have been fired.