The stock market has been transfixed by an enigmatic bond metric for the past year - one that's now flashing an unmistakably bullish signal

Stock traders on the exchange trading floor.
Stock tradersDrew Angerer/Getty Images
  • The stock market has been highly sensitive to shifts in interest-rate volatility since the Fed started tightening policy last March.

  • Falling bond-market volatility is now underpinning the rebounding investor confidence in equities.

  • The MOVE Index of US bond swings has slid to lows last seen in March 2022, when the Fed started raising rates.

After a terrible 2022, the stock market has waltzed into this year in a surprisingly merry mood, seemingly downplaying the gloom-and-doom economic predictions from Wall Street.

And it's all down to one thing: the rising conviction that the worst is over on the uncertainty over inflation and interest rates.

A gauge of future volatility in the US bond market has become the catch-all metric for traders across asset classes to track interest-rate turbulence - and it is now showing an increasingly reassuring trend, underpinning the optimism in the stock market.

The ICE BofA MOVE Index is extending a sharp slide that started in October, and has now fallen to lows last seen in March - when the Federal Reserve started its most aggressive interest-rate increases since the 1980s. It continued to fall after the central bank's latest communique on Wednesday, where policymakers notably refrained from pushing back against the upbeat trend in risk assets.

Stocks get a boost from falling bond volatility

The chart below shows how the trajectory of the S&P 500 index of US stocks has been an almost perfect inverse image of that of the MOVE index over the past year - up to this week's moves - illustrating the stock market's heightened sensitivity to the interest-rate outlook.

Chart plotting the S&P 500 index of US stocks against bond-market volatility.
The rally in stocks has been underpinned by a sustained slide in bond-market volatility.TradingView

The S&P index is up almost 8% in 2023, after rising 5.9% last month in the best start to a year since 2019 as cooling inflation stoked expectations that an end is in sight to rate increases in the US.

Chairman Jerome Powell didn't fight back in his speech Wednesday against market expectations that the Fed will soften its rate policy later this year, according to billionaire investor Jeffrey Gundlach.

"There was just something about his demeanor. He just seems like he has confidence, he feels comfortable in where he's gotten to, and I think everybody kind of sensed that.  And he obviously did not fight back against market pricing," he said in a CNBC interview.

The Fed raised benchmark borrowing costs by 25 basis points Wednesday in its latest move, the smallest increase since last March. While the central bank has boosted rates by a staggering 450 basis points over the past 10 months, it has slowed the pace of policy tightening against the backdrop of easing price pressures.

Annual inflation in the US declined to 6.5% in December, the least in over a year, from a 40-year high of 9.1% in mid-2022.

US inflation chart
US inflation has been steadily falling from the 40-year highs reached last summer.Koyfin

Trading trends in the US stock market are also reflecting increasingly positive market behavior.

The 'golden cross' is signaling bullish stock-market behavior

S&P 500 charts are now witnessing an uncommon pattern known as the "golden cross" - where a short-term moving average crosses above a long-term one - that's widely considered a bullish indicator.

That's despite many financial institutions and market experts warning in recent months of an impending recession and more equity market pain. Some of the top US banks including Bank of America and Morgan Stanley have predicted that stocks could plunge more than 20% this year.

S&P 500 chart
S&P 500 chart is flashing a rare `golden cross' pattern.TradingView

US stocks have seen sustained rallies following past instances of the golden cross pattern - notably in 2020, 2019 and 2016.

The steadily falling level of US inflation, still-firm jobs market data, China's move to reopen its economy and signs of easing energy market stress have all contributed significantly to the improvement in investor sentiment in recent weeks.

Read the original article on Business Insider