- The stock market has been highly sensitive to changes in interest rate volatility since the Fed began tightening policy last March.
- Declining bond-market volatility is now based on investor confidence in equities.
- The MOVE index of US bond swings was last seen in March 2022, when the Fed began raising rates.
After a terrible 2022, the stock market has moved into a surprisingly upbeat mood this year, seemingly undercutting the gloom-and-doom economic predictions coming from Wall Street.
And it depends on one thing: the growing conviction that the worst is over with uncertainty over inflation and interest rates.
A measure of future volatility in the US bond market has become the catch-all metric for asset class traders to track interest rate volatility – and it’s now showing an increasingly reassuring trend, underpinning optimism in the stock market.
The ICE BofA MOVE Index is extending a sharp slide that began in October, and is now down to lows last seen in March – when the Federal Reserve began its most aggressive interest rate hike since the 1980s. It continued to fall after the central bank’s latest announcement on Wednesday, where policymakers notably refrained from pulling back against bullish trends in risk assets.
Stocks get a boost from falling bond volatility
The chart below shows how the S&P 500 index of US stocks has moved almost exactly the opposite way over the past year to the MOVE index – until this week’s move – illustrating the stock market’s heightened sensitivity to interest rates.
The S&P index rose about 8% in 2023, after rising 5.9% last month for the best start to a year since 2019, as cooling inflation fueled hopes that the end of U.S. rate hikes was in sight.
Chairman Jerome Powell did not fight market expectations in his speech Wednesday that the Fed will soften its rate policy later this year, according to billionaire investor Jeffrey Gundlach.
“There was something about his demeanor. He seemed like he had confidence, he was comfortable with where he got to, and I think everybody felt that. And he obviously didn’t fight the market price,” he said in a CNBC interview.
In its latest move, the Fed raised benchmark borrowing costs by 25 basis points on Wednesday, the smallest increase since last March. Although the central bank has raised rates by a staggering 450 basis points over the past 10 months, it has slowed the pace of policy tightening against a backdrop of easing price pressures.
Annual inflation in the US fell to 6.5% in December, the lowest in a year, from a 40-year peak of 9.1% in mid-2022.
Trading trends in the US stock market are also reflecting increasingly positive market behavior.
The ‘Golden Cross’ indicates the bullish behavior of the stock market
S&P 500 charts are now witnessing an unusual pattern known as a “golden cross” – where a short-term moving average crosses a long-term average – which is widely considered a bullish indicator.
This is despite warnings by many financial institutions and market experts of an impending recession and further equity market distress in recent months. Some top US banks, including Bank of America and Morgan Stanley, have predicted stocks could plunge more than 20% this year.
US stocks have seen sustained rallies following past examples of the Golden Cross pattern – notably in 2020, 2019 and 2016.
The steadily declining level of US inflation, data on a still-firm jobs market, China’s move to restart its economy and signs of easing energy market pressures have contributed significantly to improving investor sentiment in recent weeks.