The Dual Threat to Stocks: Rising Rates and Economic Growth Dynamics

Testing Economic Resilience: How Rising Rates and Growth Dynamics Challenge the Markets

Infotrading.io - The United States' bond market is undergoing significant fluctuations as evident by the swift movement in US Treasury yields over the past three months. While the long-term yields are soaring, the short-term rates have only seen a modest hike. This dynamic, dubbed a bear steepener, is slowly straightening the previously inverted US Treasury yield curve.

For many investors, this shift towards a more traditional bond market, where long-term yields exceed short-term rates, might seem like a breath of fresh air. However, the rapid rally of rates combined with an economic slowdown is sounding alarms, reminiscent of previous financial downturns.

Alfonso Peccatiello

Alfonso Peccatiello, the mind behind The Macro Compass, offered some historical perspective on this. According to him, the bond market is currently testing the waters, probing if the economy can truly withstand these higher rates. This situation is reminiscent of previous challenging times, notably the Global Financial Crisis and the period preceding the pandemic in late-2018.

The real concern lies in the timing. When there's a surge in long-end rates accompanied by nominal growth slowing down towards the tail end of a cycle, risk assets are in peril. Such bear steepeners, Peccatiello notes, are typical of this phase in the business cycle, especially when the Federal Reserve is reconsidering its aggressive stances.

These cycles often span six to ten weeks. We're already into the tenth week, and Peccatiello warns that risk assets usually begin to crack after a few months. The repercussions could be multifaceted, ranging from something akin to the credit market freeze of 2018 to a catastrophe comparable to the 2008 Global Financial Crisis.

Previously, the Federal Reserve intervened during such crises, easing financial conditions. However, with inflation persistently exceeding the Fed's 2% target, the options are limited this time. Peccatiello's advice? Caution. He advises investors to remain wary of risk assets until a clear capitulation signal emerges from the stock or credit markets.

The upcoming monthly jobs report from the Bureau of Labor is anticipated with bated breath, especially following ADP's underwhelming employment data. A strong report might push investors towards higher yields, potentially stressing the markets. Conversely, a weak report could indicate an imminent recession, also pushing stocks and rates downwards. Peccatiello summarizes this paradox aptly: whether the job report is "too hot" or "too cold," the outcome is grim for stocks.