What Is The Yield Curve Signaling?
1.) CURVE – I’m sure not many were paying attention to the yield curve (10YR minus 2YR yields) amidst yesterday’s nice move up for stocks. But the yield curve got whacked down to just 0.20%. That’s down from a local high close on Aug 17 of 0.54%. So…who cares, right? Well, it matters on a couple of different fronts. First, it implies that oil likely holds its bullish (upward bias) trend. Second, and perhaps most importantly, the inflation forecast ticked higher yesterday to +3.67% on a year over year basis. That’s compared to the +3.40% reported CPI last month. So that’s an acceleration, which further suggests that the Fed stays more hawkish in tone, likely keeping bond yields higher for longer. Is there a chance for a slight correction in bond yields across the curve? Yes, but we’d need to see the 2yr drop below 4.38% (it’s at 4.75% now) and the 10yr below 4.66% (4.94% now) to flip the trend in those yields from up to down. I’m not holding my breath in the near term for that. Some might think that an acceleration in inflation is going to be bad for stocks. History says that's not likely as long as growth stays strong. And right now that seems more likely than not with the Atlanta Fed's Q3 2026 GDP nowcast signaling a 5.1% growth rate. Growth and inflation accelerating together tends to be healthy for stocks.
2.) OIL – Well, since I discussed rates and oil above, what about the correlation between the 10YR yield and oil? The 3 month rolling correlation between the US 10YR yield and WTI (West Texas Intermediate) oil prices hit a high of +65% last week. That's above the highs we saw during the depth of covid and the 2011 Arab Spring and only slightly below the record high of 66% seen at the onset of the First Gulf War in 1990. What does this mean? If this pattern holds, then where yields go from here will likely be less dependent on the Fed and more on the situation in Iran. Yes, it would be good to extract ourselves from the Middle East.
3.) SEMIS – Not to single out any one sector or group, but due to the AI buildout and the massive spending that has accompanied it, semiconductors are clearly an important subgroup within markets. Don’t look now, but on a valuation basis they just got cheap! Semis are back to trading at a -13% DISCOUNT to the S&P 500. That's below the longer-run pre-AI average and marks the cheapest relative valuation in more than four years. That could be important for the ongoing health of the S&P 500 too as semiconductor companies account for roughly 16–18% of the S&P 500 by market-cap weight. Will we see renewed institutional buying of the semi group? Isolated example, but if yesterday's move in Advanced Micro Devices (AMD) is any indication (+9.5%), I'd say that it wouldn't be surprising.
