From the Desk of Ian Culley @Ianculley
On Wednesday afternoon, the Federal Reserve announced another 75-basis-point rate hike following its September policy meeting.
Yields across the curve ripped, and Treasury bonds dipped.
What else is new?
An aggressive hiking regime has been the Fed’s modus operandi since March. And it's made clear its intent to stay the course.
But what does the rest of the market think about the rise in rates?
Let’s look at our intermarket ratios to gain some insight.
First, we have a triple-pane chart of regional banks versus REITs, the copper/gold ratio, and the US 10-year yield:
These key intermarket ratios tend to peak and trough with interest rates. Notice all three peaked in 2018.
As rates roll over and growth slows, investors reach for the safety of gold and REITS versus the more economically sensitive copper and regional banks.
These reactions make sense when you consider global risk assets stopped going up around the same time.
On the flip side, investors favor procyclical assets as rates rise.
For instance, the copper/gold ratio and regional banks versus REITs bottomed with rates in 2016. We witnessed the same process play out in 2020, as all three charts carved out a low and bounced higher.
That’s the basis for the positive correlation between interest rates and risk assets.
But today, that historical relationship is broken. While rates continue to rise, these risk ratios are a hot mess.
It’s not just one area of the market that has decoupled from interest rates – it’s all three major asset classes.
The copper/gold ratio highlights the commodity market's reaction, and the lack of relative strength from regional banks underpins the broad selling pressure across stocks.
Even the bond market doesn’t like the rise in rates.
Check out the overlay chart of the 10-year yield and junk versus investment-grade debt:
These charts usually move in lockstep. But junk bonds can’t catch a relative bid versus their safer alternative.
Again, not the type of behavior we would expect in a rising rate environment or, more specifically, a healthy rising-rate environment.
There’s the rub. We’re in a rising-rate environment spurned by a hawkish Federal Reserve, not economic growth and risk-seeking behavior.
What does that mean for us as investors and traders?
Risk assets are under pressure. Period. We don’t need to overcomplicate our trading plans with some grand macro thesis.
The chart of the Equities for Rising Rates ETF $EQRR tells the story:
EQRR is an ETF composed of names that benefit most from a rising rate environment – roughly 34% financials and a quarter energy stocks.
Like the ratios above, the assets that should perform well when rates rise aren’t doing so.
Instead, they’re stuck below their prior cycle highs from 2018. As long as this is the case, rising rates are most likely applying downside pressure to stocks and commodities.
This could all change. It eventually will! But that’s not the bet we want to make in the intermediate term.
For now, interest rates are in the midst of a solo ascent. That's really been the case since the spring.
When these classic intermarket relationships get back on track, then we can follow the trend with added conviction. Until then, we must remain selective when it comes to finding long opportunities.
And, as always, we must protect our capital.
Stay tuned!
Following the Fed's 75-basis-point rate hike on Wednesday, the market is pricing in another triple-move in November.
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 September 22, 2022.
Thanks for reading. And please let us know what you think.
As always, be sure to download this week’s Bond Report!
