The 2s10s Ratio Says Achtung Baby

April 2 Update: The strong jobs number is lifting the 2yr and 10yr yield. Friday AM, the ratio discussed below is tumbling to 9.3...it looks a lot like a completion of the pattern similar to 2011. Assuming this chart has some predictive ability, it's telling me we might get a "taper tantrum" yield shock in the markets soon. Yield curve control is aimed at the short-end, not the long-end. The Federal Reserve is going to start buying 2-years in May or June if that yield breaks out (based on what they've said), because that is a base screaming for a breakout. The target for the 2s10s ratio would be at least 15 and the 2s10s spread might quickly run to the 2.5 percentage point area that coincided with the end of bear markets in prior cycles. Something is different this time because if you believe the econoomy is strong, the cycles are all out of whack.

I also discuss this issue further in August 2011 inverted: Here Comes the Rate Shock and YCC. Original post: Here's a ratio chart of the 10-year and 2-year Treasury yields. Normally the 2s10s is expressed as a spread. I plugged in the ratio to see if it gave any signals. Maybe it does. Note that the horizontal doesn't appear on the peaks because the charts don't display daily data at this time scale.

The chart moves like the 2s10s spread. Peaks are in 1992, 2003 and 2011. The nadirs are more interesting to me. 1989, April 2000, November 2006, late August 2019. There's some context for 1989, but I don't think it's as relevant from the mid-1990s on, when the Fed started intervening because of financial market volatility. The prior three nadirs all signaled an oncoming recession and market decline. The Fed started intervening in September 2019.

Below shows the current ratio is where it was in 2011, at the peak of inflation hysteria in August. People were pushing the absurd notion that the U.S. would default on its debt (a precursor to Russiagate now that I think of it), gold would peak above $1900 soon after.

I like this indicator for two reasons. One, it shows what the Fedeal Reserve and central banks are doing. Each wave is more extreme because the credit bubble is larger and requires more extreme intervention. As for being a signal, Markets peaked inside of year at the prior three lows. The peak in 2003 marked a bottom for stocks, the peak in 2011 a secondary peak for inflation/commodities after 2008. The second reason is that right now, it's at a critical juncture. Could this be a secondary top for stocks or another commodities fakeout? Conversely, could we be in October 2008 when the ratio last blew past its old high? Perhaps "something is different" and this ratio will go skyward as inflation and the 10-year explode higher with the Federal Reserve holding the short end near zero. One argument for it going higher is that the 2s10s spread hasn't peaked yet. Were it to peak again around 2.5 percentage points, that would require the 10-year hitting around 2.7 percent if the 2-year didn't budge, but probably more like around 3 percent assuming the 2-yearr started moving up as well. What is different this time is that if March 2020 was the bottom of the recession, the Fed implemented expansionary monetary policy at the end of the recession instead of the start. The yield curve is reflating because the 10-year is moving up instead of the 2-year collapsing in a recession. That is the inflationary argument and it would argue for the 2s10s spead to go well beyond the former peak like the ratio chart did into 2003 and again into 2011. If I look at the chart behavior and escalated Fed response, it would argue for this chart heading for a new higher peak.

In any event, the ratio is at the 2011 peak now. There's no need to speculate on which way it will go because the trend will soon reveal itself.

Part II is here: August 2011 inverted: Here Comes the Rate Shock and YCC