Fed Chair Janet Yellen suggested there'd be another interest rate hike in 2017 and the Fed's overall tone was a bit more hawkish than was anticipated by Wall Street. That resulted in a big spike in the 10 year treasury yield at 2pm EST yesterday, the time of the Fed announcement. There's a common denominator between the Dow Jones and the 10 year treasury yield ($TNX). They've both been on fire of late. The Dow Jones rose for the ninth consecutive session. The TNX has done the same. While the TNX has fallen consistently since the early 1980s while equity prices have soared, there's actually a very strong short-term positive correlation between treasury yields and equity prices. Why? Well, new money has poured into both equity and treasury markets since 1980. Remember that money coming into the treasury market sends treasury prices higher, but treasury yields lower. U.S. treasuries are widely viewed as a safe haven and as we've moved to a more global environment, a ton of foreign money has been parked in U.S. treasuries, keeping rates extraordinarily low.
In the short-term, however, as economic conditions, or expected economic conditions, change there's movement back and forth between the two key asset classes. A choice is constantly being made whether to invest in the bond market or in the stock market. And it's these shorter-term decisions that create that short-term positive correlation between equity prices and treasury yields. Here's a short-term chart of the Dow Jones to illustrate:
Keep in mind that the short-term correlation doesn't always work. As money pours into both asset classes, we can see stocks rise while yields fall. But when yields are on the rise, that's clear confirmation that treasury selling is taking place and those proceeds have to go somewhere. Enter equities to save the day!
While the above chart highlighting this positive correlation is interesting, a more intermediate-term uptrend in treasury yields can be absolutely stunning in terms of equity performance. I looked at this relationship in much more detail in my Trading Places blog article, "The Fed's On Deck And THIS Is Why We Want To See Interest Rates Rise". Check it out and let me know what you think. You can email me at "tomb@stockcharts.com".
Happy trading!
Tom
