According to QCP Capital, stocks have overtaken fundamentals and could soon fall back.
"We say this because the two-year Treasury yield, which has been a reliable indicator of the market's direction all year, is, in fact, moving in line with BTC and ETH, while the S&P 500 and Nasdaq have rallied away," QCP said in Monday's market update.
Risk assets, including cryptocurrencies, have mostly moved in the opposite direction to the two-year U.S. Treasury yield this year as the Federal Reserve embarked on its most aggressive rate hike cycle in decades. The two-year yield closely tracks the near-term interest rate and inflation expectations.
While bitcoin and ether continue to respect the negative correlation with the two-year yield, stocks have decoupled since mid-October on hopes that inflation has peaked and the Fed will pivot toward liquidity-boosting rate cuts in the second half of next year.
The chart by QCP compares the inverted graph of the two-year yield with the S&P 500, Nasdaq, bitcoin and ether going back to January.
The S&P 500 and Nasdaq have chalked up double-digit gains since mid-October, moving away from the two-year yield. Bitcoin, the leading cryptocurrency by market value, has dropped 6%.
If bond markets, considered more rational and unsentimental than equities, believed in the narrative, the two-year yield would have seen a sharp drop. In other words, the inverted graph of the two-year yield would be much higher and in sync with the indices than it is right now.
Therefore, stocks appear to have run ahead of themselves in pricing the Fed pivot.
The relative resilience of the two-year yield compared to the 10-year yield suggests the same. The two-year note yielded 4.40% at press time – 48 basis points less than the year-to-date high of 4.88% reached on Nov. 4. On the contrary, the 10-year note yielded 3.55%, or 75 basis points less compared to the 2022 high of 4.33% hit on Oct. 21.
The two-year yield could climb toward 5%, putting downward pressure on risk assets.
That's because the new projections from the Fed's 19 policymakers scheduled for release next week are likely to show rates continuing to rise next year and peaking at the terminal rate above 5%, contradicting hopes for rate cuts next year.
"Assuming the two-year yield is still the market's way of pricing the Fed's terminal rate next year, then we potentially still have more downside, as the Fed warns it will now hike rates past 5%," QCP noted.
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