Traders are looking for a near term top in Treasury yields over the next couple of days, and the focus Tuesday will be on a rush of economic reports, including housing and durable goods.
Fed Chairman Ben Bernanke's comments last week that the Fed could reduce its $85 billion in monthly bond purchases by year end if the economy improves has made every economic data point important. In response to those comments last week, interest rates have moved sharply higher and stocks have had volatile swings. The dollar has also risen against a basket of currencies though the euro and sterling strengthened in afternoon trading Monday.
"I think what you need now is economic data points that validate Bernanke's observations that economic conditions are improving and the labor market is improving. The market is in a sort of 'show me' state right now," said Mark Luschini, chief investment strategist at Janney Montgomery.
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Stocks were rocky Monday, even as Fed officials tried to ease market concerns. Dallas Fed President Richard Fisher, a hawk and non-voting member, was seen as suddenly more dovish in his comments which helped stem the move higher in rates. The 10-year yield was at 2.54 percent in late trading, after climbing as high as 2.66 percent early in the day.
The move in bonds took pressure off of stocks temporarily. The market traded in a volatile, wide range with the Dow down as much as 250 points at one point, but ending the day at 14,659, down 139 points, or 0.9 percent. The S&P was off 19 points, or 1.2 percent at 1573.
"We're seeing substantial selling across the board. When it comes to high quality fixed income…all the way down to high yield. We're seeing the same thing in munis, high quality as well as high yield," said Zane Brown, fixed income strategist at Lord Abbett.
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The move in Treasury rates has triggered a ripple effect across credit markets. On Monday, the SPDR Barclays High Yield Bond ETF, JNK, was down 1.1 percent at 38.70, and the iShares iBox Investment Grade Corporate Bond Fund was down 0.7 percent Monday at 111.48, but it recovered slightly in after-hours trading. The iShares S&P National AMT-Free Municipal bond Fund ETF MUB was down 0.8 percent Monday.
"I think ETFs [exchange traded funds] are really fueling this downdraft in prices because people can sell ETFS very quickly and the managers of the ETFs are selling indiscriminately," he said. Brown said rates may be getting close to finding the high water mark, for now, and he suggests finding beaten down securities, particularly high-yield.
A test for the markets will be the three Treasury auctions this week, starting with $35 billion in two-year notes Tuesday at 1 p.m.
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"We stabilized when some of the Fed speakers talked the market off a cliff," said Ian Lyngen, senior Treasury strategist at CRT Capital. "Now we've got to see what the data has to say."
He said the market has to get past the end of quarter, end of first half trading this week. "It certainly feels like 2.67 was the peak for the Fed response," Lyngen said of the 10-year yield.
Luschini said he could see natural bond buyers returning at current yield levels. He said the stock market will be tested in coming weeks by the budget cuts, or "sequester" spending cuts from Washington. "If we get through that or that passes and the economic data hasn't deteriorated, it will restart the equity rally. I think we'll be turbulent here," he said.
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Investors are also watching China, where the central bank is attempting to curb speculative lending. Chinese stocks sold off sharply Monday, losing more than five percent.
Marc Chandler, chief currency strategist at Brown Brothers Harriman said it's possible there could be a "turnaround Tuesday" depending on the reaction to China overnight.
"We've had a lot of selling in the last couple of days ,and the short term sellers tend to be exhausted," he said.