The Treasury market serves a number of different functions for traders on Wall Street. One of those functions is as a barometer for anticipated economic growth and strength.
When bond traders believe the economy is going to be strong and/or growing quickly, they will typically push Treasury yields higher to compensate for the additional risk they are taking if the anticipated economic growth is accompanied by increased inflation.
One of Wall Street’s favorite Treasury-based barometers is 10-year Treasury notes (TNX). When the TNX is moving higher, it shows that traders believe the economy is growing and that the Federal Open Market Committee (FOMC) may need to raise interest rates to keep inflation in check.
Conversely, when the TNX is moving lower, it shows that traders are not as concerned with inflation. Instead, they may be more concerned about putting their money in a safe-haven asset like Treasuries. When traders move their money to Treasuries, it increases demand for Treasuries. This pushes the price of Treasuries higher and, subsequently, the yield on Treasuries lower.
TNX and the Recent Market Dip
We saw this barometer jump into action on Friday, Feb 2. The Bureau of Labor Statistics announced that average hourly earnings had increased at a faster pace in January than anticipated. This news sent a shockwave through Wall Street. Traders started to worry that the increase in wages would lead to an increase in inflation, which would force the FOMC to raise interest rates faster than anticipated. And a move like that could stifle economic growth in the United States.
In reaction to the news, bond traders sent the TNX above 2.8% for the first time since early 2014.
As the TNX rose, stock values fell, sending the S&P 500 below the 2,800 level — a threshold it has remained below ever since.
Up until this week, 2.8% has served as a solid support level for the TNX. However, mounting concerns swirling around a potential trade war, coupled with subtle signs of a slowdown in economic growth in the U.S., have finally combined to push the TNX below support.
This is a worrying sign for any traders who are hoping for future strength in the equity market.
The Bottom Line
Like any barometer, the TNX does not provide guarantees of what will happen in the stock market in the future.
But it does tell us that a storm may be brewing.
The equity market still has many bullish fundamental factors working in its favor. The expectation of strong earnings growth, increased share-buybacks and the continuation of potential benefits stemming from tax reform to name a few. But seeing the TNX break through support tells us that we can no longer take the idea that those bullish factors are going to continue lifting the S&P 500 for granted.
You can learn more about identifying price patterns and using them to project how far you think a stock is going to move in our Advanced Technical Analysis Program.
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