The Federal Reserve surely hasn’t finished hiking rates and there’s no sign of a pivot towards anything more-dovish but there’s a chance we’ve already seen the bottom for asset risk.
It all hinges on bond yields. The market is forward-looking and there’s no market more in tune with the Fed and inflation outlook than bonds.
Lately, the market has been sending signals that inflation has peaked and that the Fed hikes to around 3.50% will be enough to tame prices and re-establish price stability. The 10-year yield touched 3.498% on June 14 just before the FOMC decision and then promptly sank to 2.75%.
Late last week though, they rebounded to 3.10% on solid economic data on the services sector and employment. The thinking there is that consumers and businesses remain strong and that inflation could be more persistent.
Once the market gets visibility to the end of the US rate hiking cycle, we may see a bottom in stocks and a top in the dollar.
December 2018 is a great example as there was a swift re-think at the Fed. They had just hiked to 2.25-2.50% and said “The Committee judges that some further gradual increases” in rates would be needed.
That corresponded with a major round of turmoil with stocks nearly falling into a technical bear market. In January, the Fed pivoted and said:
In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes.
The market had anticipated the turn and stocks made a dramatic bottom on Christmas Eve then continued to rally until the pandemic.
What’s notable is that 10-year note yields peaked about six weeks before stocks with a double to at 3.25%.
USD/JPY also peaked in October 2018 at 114.50 and continued lower to 104.50 by August 2016.
Looking ahead, I don’t know if 3.50% is the peak in ten-year yields but the example of 2018 — and many other economic cycles — shows that a peak in yields is a prerequisite for a sustained turn in stocks and a peak in USD/JPY.