Trading Nation

The market is sending clear signs that economic optimism is flagging

Key Points
  • The spread between the yields on 2-year and 10-year Treasurys on Tuesday fell to its lowest since the November election.
  • The price of gold rallied nearly 2 percent and touched its highest level since the election.
Is economic optimism fading?

Some market moves across asset classes are indicating that optimism may be waning.

The spread between the yields on 2-year and 10-year Treasurys on Tuesday fell to its lowest since the U.S. election in November. Meanwhile, the price of gold rallied nearly 2 percent and touched its highest level since that week.

The spread between the yields on benchmark 2-year Treasurys and 10-year Treasurys is traditionally used to gauge market expectations about the economy. Longer-term bonds tend to have higher annual yields than shorter-term ones, and this is particularly true when economic growth is expected to increase the future inflation rate.

On the other hand, when doubts are raised about economic health, investors begin to anticipate that inflation over the long term will be lower than inflation in the near future; so longer-term yields will drop vis-a-vis shorter-term yields. By this logic, the decrease in the yield spread is showing that investors have become less optimistic about economic growth.

From a technical standpoint, this spread is coming into a key level of support around 1.06 percent, observed Craig Johnson, technical analyst at Piper Jaffray.

"From my perspective, I think we're getting that kind of retest of the [level on the] 2-10 spread. I'm still optimistic; I still think we're going to see the 10-year bond yield reach about 3.25 [percent] by the end of this year, and I continue to think it's going to be a positive sign for overall equity markets," he said Tuesday on CNBC's "Trading Nation."

If the "long end" of the curve does not rise, Johnson said, referring to the yield on the 10-year note, the Federal Reserve may not be as eager to raise its federal funds target rate.

"The Fed knows what an inverted yield curve means and would mean to the overall market; I don't think they're going to risk that, and they'll continue to push on a policy of taking it very slow," he added.

An inverted yield curve — in which the yield on long-term debt is lower than that of short-term debt — is widely considered one of the best predictors of recession.

The spread between the 10-year and 2-year Treasurys at this juncture will continue to flatten, predicted Dennis Davitt, options strategist at Harvest Volatility Management.

"The demand for longer-dated U.S. Treasury bonds is still going to be high unless we see 'too big to fail' go away," Davitt said Tuesday on CNBC's "Trading Nation," referring to the potential for the removal of regulations in the financial industry.

"As economic activity picks up, you could even see the curve go inverted with the 10-[year] staying below 3 [percent]," he said.

When it comes to the recent moves in gold, Johnson said the rally is likely just a "resetting" of the market's expectations rather than a longer-term trend higher. He's keeping an eye, specifically, on the $1,300 mark.

If gold doesn't move about $1,300, this is going to be "just another relief rally" for gold, and a continuation of a longer-term downward-sloping trend since 2011.

Gold is often considered a "safe haven" asset investors turn to when they're less excited about assets that track the economy, like equities.

Gold fell nearly 9 percent in the month following the election as stocks rallied, but the metal has since regained nearly all of its postelection losses. In fact, gold is up more than 13 percent from its December lows. On Tuesday, gold broke above its 200-day moving average for the first time since just before the election.