Over recent weeks, a powerful trend known as bear steepening has been making waves in bond markets. Bear steepening occurs when long-dated yields, such as those on 10-year bonds, rise more aggressively, causing the yield curve to tilt steeper. It’s helpful to visualise these 10-year yields as a continuum of the Federal Reserve’s anticipated interest rates for the upcoming decade, adjusted to present value. History indicates that when this trend intensifies without intervention, it has the potential to wreak havoc on both equity markets and the broader economy. Over recent months, this bear steepening has gained momentum, suggesting that markets are becoming confident in the economy’s ability to bear prolonged higher rates. However, when bear steepening coincides with an economy showing signs of weakness, it spells danger. The market has seen this pattern before in 2000, 2007, and 2018, all of which were followed by significant economic or market downturns. However, today’s context is especially concerning. In contrast to 2018, when inflation was a modest 2% allowing the Fed ample flexibility, our current high-inflation environment severely limits the Fed’s responsive measures. If history is any guide, bear steepening that coincides with signs of economic weakness can presage a downturn in the stock market. Traders could consider shorting broad equity indices or sectors that might be particularly vulnerable in a downturn.
From a technical perspective, the second Elliot Wave pictured above has so far played out with the rally to $27.5K. However, the market is still awaiting the pivotal Wave 3 selloff which should surpass the local lows to maintain the current wave analysis trend. This hypothesis would likely be invalidated if the value surpasses the previous highs of $32K. A potential catalyst propelling Bitcoin’s next ascent could be the greenlighting of a spot ETF, although the market currently awaits further clarity on this matter.
The combined signals from both the bond and equity markets underline the intricate dance between economic confidence and potential vulnerabilities. Historical patterns offer lessons, but each economic context is unique. With the current high inflation backdrop and the looming Wave 3 Bitcoin selloff, a proactive and informed approach will be critical in navigating the potential challenges ahead.
Check out the chart on TradingView here.