Stocks rallied hard Wednesday, breaking a recent pattern where the equity market has been hostage to rising bond yields.
Treasury yields surged, in a broad sell-off after a surprising jump in consumer inflation signaled the Fed could become more active raising interest rates. Yields move opposite price. The 10-year shot up to a new four-year high of 2.92 percent, a level that would have sent tremors through the stock market just several days ago.
Stock futures plunged after the early morning CPI report, but the stock market made a big comeback, with the S&P 500 adding 1.3 percent to close at 2,698. Core CPI was up 0.3 percent, more than the 0.2 percent expected.
Traders will now be watching the producer price index Thursday morning to see if there are any surprise signs of inflation lurking. Core is expected to rise 0.2 percent, but economists don't give the measure nearly the weight of the CPI. Thursday's data also includes jobless claims and empire manufacturing, both at 8:30 a.m. ET. There is industrial production at 9:15 a.m. and home builders sentiment at 10 a.m. Treasury releases data on capital flows at 4 p.m.
"Maybe this was the correction everyone said the market needs," said Sam Stovall, chief investment strategist at CFRA. He said investors waiting for the dip may have jumped in and others are afraid they missed it, in a quick spring back after a swift correction. "We only got the marginal correction, less than 11 percent. I think we're back into the FOMO mindset — fear of missing out."
But Stovall said the market could still respond to rising interest rates, which were moving higher all across the curve, and particularly in the 5-year and 7-year sector. Bond strategists said that move was the result of the market pricing in more Fed rate hikes, into next year. The market has been skeptical the Fed would actually carry through with the three rate hikes it forecast for this year and any more next year.
One positive for stocks was the 23 percent decline in the Cboe volatility index, which was at 19.26 in late trading. Traders view a level under 20 as a positive since the VIX averaged that since the 1990s, which hit dramatically low single digit levels recently.
"I think under 20 is a better scenario for the market. It's options expiration week this week, so there's a lot of noise with this drop in the VIX, which is spilling over into this rise in the equity market today," said Peter Boockvar, chief investment strategist at Bleakley Financial Group. "The market's celebrating like there's something good about higher inflation and interest rates. I think a lot of the trading is on the expirations."
Ian Lyngen, head of U.S. rates strategy at BMO, said the bond market is being driven by flows and technicals. The next level to watch on the 10-year was 2.93 percent, but overnight trading could be an important factor.
"I think people are content to press the move to see if we can get to 3 percent," he said. The 3 percent level on the 10-year is seen as one that the stock market would not be able to tolerate, although some stock strategists say the market may already be adjusting to rates at that level.
Analysts say it's possible the stock market could retest its lows, back to the 200-day moving average on the S&P 500, which was at 2,535 Thursday. But because the market is trading wildly, it could also easily cross a key technical level at 2,702 and head higher toward the 50-day moving average at 2,721, a key level to recapture.
"I'm thinking maybe this market ends up pausing in between that zone, pausing or even beginning a retest," Stovall said.
Todd Sohn, technical analyst at Strategas, said the market could be gearing up for another downturn to test that 200-day. He said he would have liked to see better breadth, meaning more advancing issues.
One positive is that financials have been leading the advance, and analysts say that's a good sign for the market. The S&P financial sector was up 2.3 percent and was the best performer Wednesday.
Sohn looked at 10 market corrections and found that banks only led once, during the bursting of the tech bubble in 2000.
"Usually you see banks and the more risk-on groups take a back seat during a correction. They outperformed on a relative basis even though it was a painful period for stocks," said Sohn. "Perhaps the rate story is involved this time. That has to be a big factor in their outperformance."