Market expectations on what's next
Yield Curve: Europe
Yield Curve: US
Stock-Bond Correlation
Insights
CONCEPT
Yield curves plot the yield paid by bonds over time. They predict economic activity and reveal investor expectations on future growth, inflation and changes in interest rate. They act as a COMPASS to help us confirm which economic scenarios and phase of the cycle investors are currently pricing-in. We double-check those views by monitoring the short-term interaction between stocks and bonds via their 10-week correlation.
CURRENT READINGS
- In Europe, the German yield curve is currently upward-sloping (normal) with the 10Y-3M spread at +1.01%, pricing an ongoing economic expansion. Compared to last month, the curve has flattened a bit. In US, the yield curve is currently upward-sloping (normal) with the 10Y-3M spread at +0.65%, pricing an ongoing economic expansion. Compared to last month, the curve has remained relatively stable.
- Focusing on recent asset behavior, the 10-week stock-bond correlation in US between the S&P 500 index and US Treasury yields is just mildly positive (low and negligible) at 0.05: this means NO LINKS offered by bonds against stocks. What should we do then?
MARKET IMPLICATIONS
The EU yield curve is bull flattening: investors predict long-term yields to fall faster than short-term yields on lower growth and inflation in the future. The positive label "bull" applies to long-term bonds that would do well in such scenario, while stocks are likely to reprice. The US yield curve is instead bear steepening: investors predict long-term yields to rise faster than short-term yields on the back of faster growth and inflation in the future. The negative label "bear" applies to long-duration bonds that would suffer in such scenario. Stocks would do well if growth will accelerate, poorly if interest rates would rise and growth fade.
Looking at the ongoing relationship between US bond yields and stock prices, their recent 10-week positive correlation indicates that bonds have been hedging stock movements recently.
In general terms, a positive correlation shows that bond yields and stock prices have been moving in the same direction, providing safe-haven diversification inside an investment portfolio. A negative correlation shows that yields and stocks move in opposite directions (with the scenario of rising yields and falling prices being the most painful for investors), common in periods of higher inflation.