Bear Steepening Raises Red Flags for Stock Market Investors

investing.com:

There is a rare and powerful trend occurring in bond markets.

History shows that if left unchecked, it can cause serious damage to equity markets and the economy.

Over the last 3 months, US bond markets have been in an aggressive and prolonged period of bear steepening of the yield curve.

The TMC VAMD shows and color-codes volatility-adjusted moves across asset classes: the darker the color, the more outsized the move in historical context.

Bear steepening happens when interest rates move higher but it’s long-dated yields that take the lead, hence shifting the entire curve higher but also steeper.

The chart above shows the 10-year market-implied path ahead for Fed Funds before and after bear steepening and the net change in the box below.

To understand it, think of 10-year yields like a strip of all future Fed Funds for the next 10 years discounted to today.

The reason why we didn’t see 10-year Treasury yields breaching 4% until recently is that the prevailing yield curve regime was bear flattening: the Fed would impose higher yields in years 1-2 of the chart above, but the market would discount damage to growth and inflation down the road and price materially lower Fed Funds from year 3-10 with convergence towards a ‘’neutral’’ of 3% over time.

That’s why higher terminal rates at 5%+ didn’t push 10-year yields higher than 4.00%.

But over the last 3 months, the music has changed with the bear steepening.

Recently instead markets priced in a mildly higher terminal rate at 5.45% and most importantly listened to the Fed’s message: no cuts anytime soon.

But while in the past that meant more cuts would be priced in immediately after, the bear steepening move implies that markets believe the economy can handle higher rates for