News feeds are littered with anticipation about Yellen’s speech on Friday at the Jackson Hole summit. Will she be more hawkish and talk of rate increases in 2016, or will she cede t the ‘market risks’ that caused the Fed paus in the past? The big trades from this are somewhat expected, that a hawkish fed will boost the dollar, spike yields on government bonds, and hurt commodities.
Looking at the relationship between longer term bond yields and the markets you will see that yields create the floors for the equity market and also dictate where new highs reach their limits. And market slump where bond yields dropped (priced of bonds rallied) the downturn was acute and quickly recovered. Where the yields rose (prices dropped in the above chart) the S&P suffered a greater downturn and subsequent recovery.
Much of this is due to the market expectations of Fed action after any market shakeout where the expectations of bond yields going up are less and less likely. This correlation has increased since the start of the year, linking stock and bond prices together. Should Yellen’s speech come out more bearish and rates start to rise in anticipation, stocks will be forced to look at their own fundamentals again to determine fair prices. After earnings season this may not be a good sight.