7/15/26 update
Confirmation of Short and Intermediate Term trends
Equities are on their way to their third weekly gain in a row, following four red weeks in June. Its been choppy however, there has been a wide disparity in the returns based on the composition of one’s portfolio. Semiconductors has been the most crowded trade all year, and we saw rotation away from the leaders this week. This leads to increased breadth in a gently rallying index, which is overall a bullish characterization. Rates continued their rally after the PPI followed through confirming the CPI data indicating a material decrease in inflation concerns. The 2 year and 5 year UST yields both fell 5 bps today after a similar move yesterday, the 10 and 30 year rallied as well but less, as expected. Its been a while since I have defined the different trends in the bond market and I have a number of new subscribers so I’m going to do so now:
Bull Steepening - when Bond prices rise and yields fall, but shorter maturities rally more than longer maturities and the spread increases. This typically happens when inflation fears subside, but without concurrent increasing fears of slow growth or recession. It is typically bullish for equities as it indicates a strong economy where growth in production and incomes exceed growth in prices. Conditions in which the Fed doesn’t need to intervene, and the underlying conditions lead to prosperity.
Bull Flattening - when Bond prices rise and yields fall, but longer maturities rally more than short and the spread decreases. This can occur at either high absolute levels of rates or low. When it occurs at low levels, such as the 2018-2020 period, it is a bearish signal for equities as it indicates there is slow growth but no room for monetary stimulus to improve conditions. When it occurs at high levels of absolute rates it can be bullish, as it likely reflects the market’s approval of hawkish short term rates properly subduing inflationary pressures, such as in the early 1980s.
Bear Steepening - When bond prices fall and yields rise, and the long end of the curve sells off harder than the short end. This is most likely due to the market concluding inflation is running away from the Fed, and that rate hikes are needed but not occurring. This is the most dangerous of all the signals because it results not only in a depreciation of bond value, but is a signal to equities that rate hikes are about to come in a series. We saw this in early 2022 and it led to material losses to both asset classes.
Bear Flattening - When short term yields rise more than long term yields. This is the most complex of the conditions and what we have been observing over the last three quarters. It requires a view that the Fed is more likely to hike than cut, but it does not indicate a lack of credibility in the Fed response like a bear steepening. It can be due to the bond market being concerned about inflation but the equity market not. It can be due to a lack of consensus within the bond market on the next direction of Fed rates, or it can be due to a high level of credibility accrued to the Fed, and that only one or two hikes will be needed. It is neither bullish nor bearish for equities as it indicates the primary trend is unclear. And that is where we find ourselves today.
Therefore, if the primary trend emerges bullish for rates with a bull steepener replacing a bear flattener, that would be bullish for both equities and bonds. I think that is the most likely case, but far from conclusive at this point. I’m going to dig into the details for my paid subscribers:
