A Classic Intermarket Relationship

From the desk of Ian Culley @IanCulley

It’s the day after the FOMC announcement, and markets are mixed. They’ve already moved past yesterday’s 75-basis-point hike and are now in the process of pricing in all available data, including the prospects of future Fed policy.    

Instead of getting caught up in the recession chatter and what the Fed might do next, let’s focus on one undeniable fact: The 10-year US Treasury yield $TNX is still at a key inflection point.

I know we’ve been obnoxious about the US dollar and rates. They continue to be two of the most important charts out there. That’s the environment we’re in – plain and simple.

And with the 10-year yield stuck just below a critical shelf of former highs, there’s no better time to remind ourselves of some classic intermarket relationships.

Here’s a chart of the US 10-year yield overlaid with the Metals and Mining ETF $XME with the ARK Innovation ETF $ARKK in the lower pane:

Some assets thrive in a rising rate environment, while others tend to perform better when rates are falling or remain low. That’s exactly what this chart highlights.

We consider metals and mining stocks procyclical assets because they benefit from periods of economic expansion, much like their associated commodities. It’s no wonder the chart of XME looks very similar to the 10-year yield during the past few years.

These stocks do well when rates are rising.

On the flip side, we have ARKK in the lower pane. We’re using this chart as a proxy for long-duration assets.

Think of all the techy, growth names that the average investor has relied on during the last cycle. These types of assets have been rock stars during the past decade of low interest rates.

The market environment has dramatically changed during the past year. 

As rates have rallied since last year, long-duration assets have sold off aggressively. Even with the recent bounce off its 2020 lows, ARKK is down more than 50% year to date. And US Treasury bonds have suffered a similar fate. 

But if interest rates begin to roll over at these former highs, that could set a floor for the most beaten-down areas of the market. Of course, that's yet to be seen. But that’s the point of the post.

Rates are at an inflection point. 

Their next directional move will have far-reaching impacts across the stock market. Some assets will benefit from a continued rise in US yields, while others will likely receive a much need boost if they fall.

And by the off chance rates just hang out and chop sideways, I think stocks do well, more broadly.

Stay tuned.

Countdown to FOMC

After yesterday's announcement, the market is pricing in a 50-basis-point hike at the September meeting.

Here are the target rate probabilities based on fed funds futures:

Click the table to enlarge the view.

This data is from the CME FedWatch Tool as of July 28, 2022.

Thanks for reading. Let us know what you think.

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