US Interest Rates and Stock Indexes - An Excerpt from CRB'S Futures Market Service

E-MINI S&P 500 STOCK INDEX

Sep S&P E-minis in the past two sessions have rebounded sharply higher from a 1-3/4 month low on reduced concerns about a slowing global economy.  Bullish factors for stock prices include (1) carry-over strength from a rally in Asian and European stock markets which bolstered confidence in the global economic outlook after China's manufacturing activity accelerated more than expected in August and Australia's economy expanded in Q2 at its fastest pace in 3 years, (2) Fed Chairman Bernanke’s comment that the Fed “will do all that it can” to ensure a continuation of the economic recovery and that the “preconditions” for growth in 2011 are “in place,” and (3) the larger-than-expected increase in Aug US consumer confidence (+2.5 to 53.5 versus expectations of +0.3 to 50.7).  Bearish factors included (1) Morgan Stanley’s cut in its second-half GDP estimate for the US to 2.0%- 2.5% from an earlier estimate of 3.0%-3.5%, and (2) the FDIC report that said US “problem” banks rose to 829 at the end of Q2, up +7% from 775 at the end of Q1.

Fundamental Outlook—Bull Market Correction—US stock prices remain in correction mode on concern about the sustainability of the economic recovery.  Earnings have been strong, but risks to stock prices remain from a weak economy and from tax-related selling of stocks by high-income taxpayers who may face much higher tax rates on Jan 1 if the Bush tax cuts are not extended.  The S&P 500 is trading at a low forward P/E of 13.0 vs the 5-yr avg of 15.3), which reduces the downside risks and leaves room for a resumption of the bull market when the economy regains upward momentum.

US 10-YEAR T-NOTES

10-year T-note prices retreated from their recent 1-1/3 year nearest-futures high and the 10-year T-note yield jumped back above 2.50% as better-than-expected economic data prompted a rally in equity markets that sapped the safe-haven demand for Treasuries.  Bearish factors include (1) the unexpected increase in the Aug ISM manufacturing index (+0.8 to 56.3 versus expectations of -2.7 to 52.8), (2) the unexpected increase in Jul US pending home sales (+5.2% m/m versus expectations of –1.0% m/m), (3) the stronger-than-expected Jul US personal spending report of +0.4% versus expectations of +0.3%, and (4) comments from Dallas Fed President Fisher who said he is "reluctant" to expand the Fed's balance sheet to stimulate the economy unless there are additional tax and regulatory policies in place to spur job growth.  Bullish factors include (1) the unexpected decline in jobs in the Aug ADP employment change (10,000 versus expectations of +15,000), (2) the Aug 10 FOMC meeting minutes in which policy makers said they saw “increased downside risks to the outlook for both growth and inflation” and voiced concern that further shocks would cause “significant slowing in growth.”

Fundamental Outlook—Bull Market Correction — T-note prices are correcting lower from their sharp 5-month rally.  Stronger-than-expected economic data prompted a sharp recovery in stock prices which reduced safe-haven demand and fueled long-liquidation pressures in Treasuries.  T-note prices still have support from a lack of inflation and speculation the Fed will expand its quantitative easing program.  Yet, yields are at abnormally low levels from an historical perspective, meaning an eventual climb in yields is likely when the labor and housing markets recover and the economy begins to normalize.

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