Wednesday's Market Minute: Breaking the Camel's Back

Something somewhat new happened in the market’s response to Jerome Powell’s renewed hawkish tone on Tuesday. Ten-year Treasury yields were little changed, and bank stocks did worse than tech. While the Fed chair’s language was the most aggressive yet of 2023, the response in the market – apart from being down overall – didn’t follow in the footsteps of last year’s bear.

That’s probably because we’re getting very close to taking out the legs of the economy. The one trend that’s remarkably consistent is the Treasury yield curve’s persistent, deepening inversion. It’s chart is a stair-step process lower over the past year. When it goes sideways, thank the strength of the labor market for keeping the machine running. When it goes south, thank the Fed (or more philosophically, the natural cycles of the economy that we're learning are not as easy to tame as we thought).

The dollar had a big jump on Tuesday and looks like it’s on its way higher to catch up with Treasury yields, which stayed much nearer to their highs than the dollar over the past quarter as global central banks ramped up their intensity relative to the Fed. Now that JayHawk has awoken, the greenback is likely to catch up to yields. What happens to bonds may be less obvious at this point.

Hopefully, the 10-year yield keeps moving higher. That’s the best option investors have right now, because if it doesn’t, it probably means the next series of rate hikes are the straws that will break the camel’s back of the U.S. economy. 

Focus on the financials, which dropped 2.5% Tuesday. Regional banks specifically declined 3.2% and are back near 52-week lows. The chart is looking ugly for a group that is deeply embedded in the economy, from housing to small-business lending. If economically-sensitive groups like these decline as much as rate-sensitive growth stocks in the next phase of hikes, like they did yesterday, the message should be clear: something's about to break.

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