Traders are also keeping an eye on Europe, which is expected to be relatively quiet in the coming week but has delivered plenty of unexpected headline risk in recent weeks.
Jefferies Treasury strategist John Spinello said the markets show some signs of calming down. "The risk profile started changing in the middle of the (past) week with the stabilization of Europe and the stabilization of the stock market. You have stocks going up and the currency stable. It's going to be hard to get the fear trade into the (bond) market," said Spinello. Treasurys have been the big beneficiaries of market turbulence in a flight-to-safety trade. Yields rose at the end of the week, as those buyers stepped back.
Deutsche Bank's chief U.S. equities strategist Binky Chadha said the stock market's current choppiness is probably here to stay for now and could last about two months, if history is a guide. He said episodes of risk aversion have averaged 36 days, which would be mid-July, and that would be around the time when there is a heavy roll over of debt in Europe.
"That's a risk, and the market's going to remain jittery about that. We think generally earnings could be a trigger for a move up in the market, like it has in the last few earnings seasons," he said. "...If we're going to believe what the CEOs are saying, which is they're seeing limited impact from Europe, then earnings are going to surprise again."
Linked at the Dip
Chadha said there has been an interesting linkage between asset classes as the stock market corrected since early May. He said the correlation between stocks, bonds, credit, oil and currencies has never been higher and is at a record 65 percent. That correlation is measured by the proportion of variation in returns, and is now even higher than it was at its peak in late 2008, just after Lehman Brothers failed. Chadha said the correlation averages 30 percent.
"This is all asset classes. It's all basically the same trade, and so if the correlation across asset classes and stocks is so high, it's always important to look at valuation and what's happening to earnings, what's happening to multiples, but you don't want to emphasize that too much because what's happening is systemic, and it's across everything. It's basically a great de-risking," he said.
Chadha said unlike when Lehman Brothers failed, investors went into a "de-risking" mode just because of fear of an event, not an actual event.
"We've basically argued since the March bottom last year, that the market has basically been skeptical and we've spoken about how at some point, the market was just going to have a fit, and unfortunately, based on all the indicators that's exactly what's happening," he said.
"This market moves up basically on proof, and right now we've got a whole set of concerns. There's the U.S. recovery, Washington regulatory risk. There's China slowing. The market is in need of proof on all these things to calm down. It's a pretty slow process. It usually takes a couple of months," Chadha said. " The market needs to check off all of the boxes before it goes back up."
Citigroup's Amitabh Arora, head of U.S. rates strategy, said he thinks markets will be calmer when there's an all-clear sign on European banks. Markets have been nervous about signs of stress in the interbank lending market and the health of Europe's banks in general because of their high exposure to European sovereign debt.
"To me the sovereign debt roll over is not the issue any more. It's the bank debt roll over. They have some cash on hand so they can fund it for some time, but there's no way they can meet six months of funding requirements entirely through internal accruals," he said.
"If you look at the CDS (credit default swaps) spreads on euro area banks, these are as large as they were at the time of the Lehman bankruptcy," Arora said, noting U.S. banks are much tighter. He did say there was some improvement in the past week. Bond investors use credit default swaps as insurance against default risk.
Arora said these concerns and others have put the flight-to-safety trade into Treasurys, which he thinks would be seeing higher yields on a fundamental basis. The 10-year was yielding 3.229 late Friday.
"There is a concern that growth is faltering, partly from loss of business confidence around Europe, a loss of business confidence around financial sector regulation, and uncertainties in the political environment. That's weighing on the market," he said.
"If euro area concerns blow over, we should see a 20 to 25 bps (basis points) backup in Treasury yields. We will need to see over the next three months no serious funding problems or unsecured borrowing issues for the banks, and then those are needed before it blows over," he said.
Arora said there is currently no specific scheduled roll over of bank debt on the horizon.