Daily chart - Comparison of S&P 500 and 2-year Treasury note

(Click on image to enlarge)

• Trump trade - Expectation that Trump would embark on an expansionary fiscal policy - leading to higher growth/higher inflation pushed up Treasury yields, stocks and inflation expectations as represented by the 5-year inflation expectations.
• The strong positive correlation between the S&P 500 index and the 2-year treasury yield remained intact till mid-December.
• Post-Fed rate hike, the 2-year yield started losing height, but the index continued to move higher. On the chart, we can see higher lows formation on the index and the lower tops formation on the 2-year yield.

The 10-Year breakeven rate is losing height

(Click on image to enlarge)

• The breakeven inflation rate is a market-based measure of expected inflation. It is the difference between the yield of a nominal bond and an inflation-linked bond of the same maturity.
• Inflation expectations started rising well before Trump won the elections, but the steep rise happened during the November-December period. It continued to rise in January but is now showing signs of exhaustion.

Trump trade running out of steam

The price action in the treasury yields and inflation expectations suggests the Trump trade could be running out steam. Moreover, markets need Trump to deliver something on the fiscal front.

What it means for the S&P 500

The S&P 500 is likely to track treasury yields lower… given the strong positive correlation since November.

Prior to Q3 2016, rising yields were a curse for the equities, however, that equation changed with oil price recovery and Trump victory. Markets now read higher yield as a sign of growth. Hence, the drop in the yields and inflation expectations could drag down the S&P 500 index.

Still, caution is advised as strong earnings could push the index higher. Bears are advised not to get too ambitious and keep tight stops on their short trades.