Perhaps the most important is the credit channel; the substantial curve flattening that happened recently in anticipation of the Fed hike next year has made lending standards tighter for small businesses.
We define four states of the stock-bond relationship based on the directions of stock price and bond yield movements; stocks fear tightening more than true risks, while bonds are more responsive to Risk-On and Risk-Off.
We looked at the periods around the end of the three previous easing programs (QE1, QE2 and Operation Twist) and compared those patterns with the current ones for various measures. The current patterns from both an economic and a market front bear enough resemblance to the previous ones to make us a bit uncomfortable. February’s market action was encouraging, but it is still too early to rule out a post-QE fizzle.
If interest rates keep going higher from here, we would run the risk of derailing a still-fragile recovery. As long as the Fed tapering uncertainty exists, we expect higher volatility on the 10-year yield to persist in the mean time.