Interpreting the Yield Curve

At this point in the economic cycle, when the Fed is still on the rate hiking path, signals from the yield curve are taken and over interpreted.  Yes, a flatter yield curve is a signal from the bond market that the Fed has limited room to tighten further, but a steepening yield curve at this point is not the opposite signal.  A steepening yield curve (has to be more than a few days phenomena) is usually a sign that the economy is getting worse and that the Fed should stop tightening all together.  It is almost always a bull steepener, so it can't be like the move you saw on Friday (bear steepener, where the long end rates go up higher than short end rates). 

The most economically sensitive part of the 2s to 30s yield curve is the belly (5-7 yrs), and after that short to intermediate (2-5 yrs), and then the 10 yr, and lastly the long end.  So what you see in a bull steepening yield curve that persists after several rate hikes is a warning sign to markets that the Fed's next move is more likely to be an easing than a tightening. 

I am looking for that bull steepening in the yield curve that lasts for several weeks as the first sign that the trend in the bond market has changed and instead of making higher highs in rates, we will be making lower lows.  We still have not seen a sustained bull steepener during this rate hiking cycle, so it is still uncertain if we have seen the highs in 10 year yields.  But once we do get that bull steepener, it is almost a lock that the bond market will be entering a bull market. 

The SKEW index is pointing to a lot of risk aversion in the coming weeks, and usually that predicts weakness more often than strength.  The uptrend looks exhausted, and a weakening bond market is another burden for stocks.  I shorted a small amount of SPX late last week, and will look to put on a bigger position in the coming days.