Investors weren’t too ruffled by the outcome of the Federal Reserve’s policy meeting, but it did appear to foster one market development that should cheer stock market bulls, according to Renaissance Macro’s Jeff deGraaf.
In a Thursday note, deGraaf, RenMac’s chairman and chief technical analyst, focused on the selloff in Treasurys following the Fed’s Wednesday policy meeting, which drove the yield on the two-year note TMUBMUSD02Y, -1.37% to a nearly nine-year high. De Graaf said the two-year yield’s rise to a new cycle high was partly in response to the Fed signaling it intends to deliver another rate increase by the end of the year and partly reflected investor confidence in future growth prospects. Yields and bond prices move in opposite directions.
“This is a big deal to us for a few reasons,” deGraaf said.
For one, it offers reassurance that the Fed isn’t being overly aggressive when it comes to monetary tightening. History shows that when the Fed gets ahead of itself, the market tends to see through it. Instead of rising as it did Wednesday, the two-year yield in those cases tends to get driven below the fed-funds rate.
Second, higher rates have a positive correlation with S&P 500 SPX, +0.06% returns over the intermediate term, he said. (see chart below).
Treasury prices regained ground Friday, pulling the two-year yield back from its high, as renewed tensions over North Korea inspired a modicum of demand for traditional haven assets.
The U.S. dollar also retreated slightly versus most rivals Friday, but also stands to be a beneficiary of the rise in yields, particularly at the two-year level, that followed the Fed meeting. Indeed, the dollar jumped significantly as yields rose in response to the Fed’s reiteration of its plan to deliver another rate increase by the end of 2017.
Higher yields make U.S. assets more attractive, which in turn enhances the value of the currency (see chart below).
Analysts at Morgan Stanley said the sharp Wednesday rebound by the greenback shows “just how detached” the dollar had become from monetary policy expectations. The ICE U.S. dollar index DXY, -0.05% a measure of the currency against a basket of six major rivals, was off 0.2% on Friday but is holding a weekly gain of around 0.2%. The index is down 10% since the end of last year.
Indeed, the dollar’s weakness in 2017 despite continued underlying U.S. economic growth and the prospect of further tightening by the Fed, which has already delivered two rate increases this year, wrong-footed and perplexed a number of currency traders.
Read: Overly complacent investors may be in for a rude Fed wake-up call