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Stocks had been spooking bonds all summer. Now it's the bond market's turn.

Even before Friday's jobs report made it much more likely the Fed could raise rates in December, stock traders have been keeping an eye on the bond market for clues on the Fed's first rate hike. Yields on the 2-year note, the most policy-sensitive, rose to the highest level in more than five years Friday, after the October payrolls came in at 271,000, well above Wall Street's forecast of 185,000.

"Now that you've got December pretty much in stone, which is fair," said John Briggs, head of strategy at RBS. "…The thought in the bond market is [that] the bond market is going to move towards [the] path. I think that's what the equity market is looking toward the bond market for – it's about the path."

The Fed has been promising a slow move — or path — higher for rates, but the market is still pricing in just three rate hikes by the end of 2016, he added.

Traders work on the floor of the New York Stock Exchange.
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"You're going to see just how far the bond market takes this, to see if the market thinks we're on the way to a full-blown interest rate hiking cycle or something less than that," said Briggs.

Stocks floundered Monday, with the S&P 500 off nearly 1 percent at 2,078, as traders weighed the potential for a Fed rate hike amid signs the global economy remains weak. China's trade data disappointed overnight, showing exports fell for a fourth month and imports also dropped, making for a $61.64 billion record-high trade surplus.

As for Tuesday, markets will pay attention to the Treasury's 1 p.m. ET auction of $24 billion worth of 10-year notes, the most important since the jobs report. The Treasury auctioned 3-year notes Monday, and those notes received a lukewarm reception, with dealers taking more than their usual share. There is also the NFIB small business survey at 7:30 a.m. ET. Import prices are released at 8:30 a.m. and wholesale trade is at 10 a.m. Chicago Fed President Charles Evans speaks at 2:30 p.m. on a panel of government debt.

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In recent comments and in a post-meeting statement, Fed officials successfully pushed the market toward believing in the potential for a December rate hike, after confusing investors with mixed messages for weeks. The Fed pushed the door open for a December rate hike when it indicated in its October meeting statement that it could raise rates at its December meeting if the jobs and inflation data were strong enough.

Fed Chair Janet Yellen and other Fed officials then drove the message home last week by reiterating the Fed could hike rates next month, after holding them at zero for seven years. The final push came from the strong jobs report which also included better-than-expected wage growth.

"The key battle was last week and that sent the message. I think we're in the middle of seeing some assets reprice; bonds and the dollar, and (stocks) will be keying off those other assets," said Michael O'Rourke, chief market strategist at JonesTrading.

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The 2-year yield rose as high as 0.958 percent during Friday trading, from 0.84 before the jobs report. Yields rose again Monday, with the at 0.89 percent, up slightly from Friday's close. The 10-year note yield was higher at 2.35 percent Monday. The dollar index was flattish Monday, but it was up more than 2 percent in the past week.

Just weeks ago, the bond market was focused on the fact the Fed could hold off if there was too much distress in the stock market, which was selling off on concerns about China and global weakness. The stock market retested its summer lows in late September, and the S&P 500 has climbed 11 percent since then in part on the expectation that the Fed would stay on hold for months to come.

"I think Friday was a seminal event. We may for the first time get that rate hike, and it's going to expose a lot of vulnerabilities in a lot of places," said Peter Boockvar, market strategist with Lindsey Group.

"I think people are being reminded that we had an unbelievable move here, and a lot of that move was because of the view that the Fed may not raise rates … I think you have to keep your eye on the dollar and interest rates here. A five-and-a-half-year high in 2-year note yields, you have to pay attention to. Financial conditions are tightening."

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O'Rourke said he expected the stock market to trade in a choppy fashion, either moving sideways or lower into the year-end, but he does not expect another sell off like the one this summer that drove the S&P 500 down more than 11 percent.

Indeed, many strategists still expect stocks to be lifted by seasonal factors, despite the fact that the market's forward price-to-earnings (p/e) ratio is elevated once more. According to S&P/Capital IQ, the forward S&P earnings p/e is 17.2, well above the average 16.2 over the past 15 years.

"It's the market finally saying we're going to have tighter monetary policy here," said O'Rourke. "After seven years of zero interest rate policy, are you going to pay 18 or 19 times earnings for the market after seven years of the most beneficial environment you could have."

Some strategists have raised their targets for rates, and Nomura's George Goncalves says he now it expects the 10-year yield to be at 2.20 percent at year end, up from his prior forecast of 2.0 percent, lower than the current level. But the bond market could overshoot and yields could move higher on better data or other factors. Yields move opposite to prices.

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"If we don't have our sea legs in the bond market, it could reverberate through other markets … When you move away from no longer being at zero, you need to understand what that means. The only place you're going to get a good handle on that is the bond market," said Goncalves, head of rate strategy at Nomura. "Every asset class has really been buttressed by this notion of zero rates forever. And if that goes away, you lose your anchor."

Briggs said he expects the 10-year to top out at 2.50 but strategists add the market could push into higher ranges.

Besides data Tuesday, there are a few earnings including from Beazer Homes, Tencent, DR Horton, TerraForm Global, Rockwell Automation, Wayfair and Markit.

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Goncalves said the 10-year auction could fare better than the 3-year, and it may be helped by investors buying the issue ahead of a new 10-year futures contract, expected in January.

He said the 30-year auction Thursday will also be important and the big data of the week will be October retail sales on Friday. An important reading on the consumer, Goncalves said he will also be watching for any signals from holiday shopping this year, as it will be the consumer side of the economy that will have to drive growth until manufacturing picks back up.

"We have evidence that the service sector is doing better than the real economy," he said. He said it will be buying power that will get inflation back on track, and that is an important consideration for the Fed when it meets in December.