Will Rising Rates Lead to a Stock Market Bloodbath?

From the Desk of Ian Culley @IanCulley

Rates are on the move again.

The US 30-year Treasury yield $TYX cleared numerous hurdles this week. 

It broke above a shelf of former highs, climbing to its highest level year-to-date. And, perhaps more importantly, it reclaimed its former 2014 high.

Add a potential failed breakdown in the US dollar index $DXY, and it’s starting to feel a lot like 2022.

But should we expect another bloodbath?

…Not necessarily.

Here’s a quick look at the US 30-year yield resolving higher from an 8-month consolidation:

The chart tells the story: Interest rates are kicking off the next leg higher as the underlying uptrend remains intact.

It’s no longer a matter of whether rates will fall later this year. It’s now more a question of how fast they will rise.

A sharp increase in yields would no doubt apply pressure to growth sectors and, by extension, the major US indexes. We’re already witnessing a correction as the Nasdaq 100 has retreated roughly 3.5% over the past two weeks.

But it’s essential to put the current state of the markets into perspective.

The long-duration bond ETF $TLT is printing fresh 9-month lows just weeks after the tech sector ETF $XLK posted a new all-time high.

XLK carved out a significant bottom the last time TLT traded at these levels – quite a different picture from today.

The chart highlights the central relationship between stocks and bonds. Equities have ripped higher in an environment where interest rates have chopped sideways.

Stocks crave an absence of bond market volatility.

That’s why the focus centers on how rates rise, as it will dictate the nature of the current pullback. 

Consolidations among H1 leadership groups likely accompany a slow, steady crawl in yields. 

On the other hand, a steep climb in rates will bring a more severe downside correction for the major US stock indexes. 

Meanwhile, cyclical value-oriented sectors are resuming a leadership role. This comes with plenty of fresh trading opportunities in materials, industrials, and energy. And we expect more as sector rotation unfolds.

While we monitor the pace at which rates rise, they’re rising against a backdrop of healthy rotation and new all-time highs in tech – the polar opposite of last year’s action.

What do you think? 

Are you buying the breakouts in energy?

Let us know. We love hearing from you.

Countdown to FOMC

The market is pricing in a pause after last month's 25-basis-point hike.

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 August 3, 2023.

Thanks for reading.

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