- The U.S. two-year/10-year yield spread is narrowing as investors assess the economic implications of higher short-term interest rates.
- Markets are pricing in the possibility of another Federal Reserve rate hike before year-end, with inflation remaining a key variable.
- Energy and materials continue to show strength, while financials lose momentum and parts of the technology sector begin to turn higher.
Interest rates remain front and centre for investors this week as StoneCastle Investment Management portfolio manager Bruce Campbell examines what the bond market could be signalling about the economy.
In the latest edition of Markets in Motion, Campbell focuses on the spread between two-year and 10-year U.S. Treasury yields following the Federal Reserve’s latest rate increase.
As the spread moves closer to zero, Campbell says investors should keep a close eye on the yield curve for signs of slowing economic momentum.
This article is being disseminated on behalf of StoneCastle Investment Management, a third-party issuer, and is intended for informational purposes only.
Market expectations are also shifting toward the possibility of another rate increase before the end of 2026. According to the data presented by Campbell, markets are pricing in around 1.3 additional hikes, although with only two Fed meetings remaining this year, the path will depend heavily on incoming inflation data.
Investor sentiment sends a signal
Campbell also turns his attention to investor sentiment, highlighting SentimenTrader’s Smart Money/Dumb Money Confidence Spread.
The indicator tracks differences in sentiment between investor groups historically characterized as more sophisticated or more speculative. Campbell notes that recent movements have seen the so-called smart money recover from deeply pessimistic levels and cross above dumb money confidence.
While the indicator does not determine where markets move next, Campbell sees the change as another signal worth monitoring alongside rates and inflation.
Energy and materials show strength
Relative rotation graphs are also highlighting changes beneath the surface of Canadian and U.S. equity markets.
On the TSX, materials remain strong despite volatility in gold and copper prices, with a number of copper stocks reaching new highs. Energy is also beginning to show improving momentum.
Financials are moving in the opposite direction. Canadian banks have enjoyed a strong run, but Campbell is watching for signs that capital could begin rotating away from the sector.
A similar picture is developing south of the border. U.S. energy remains strong while financials are turning lower.
Technology could be one of the more interesting areas to watch. Campbell notes that some of the Magnificent Seven stocks have started turning higher, potentially providing an early indication of renewed momentum within the sector.
Watch the full video above for Bruce Campbell’s latest analysis of interest rates, investor sentiment and sector rotation.