Thursday, April 13, 2006

Interesting Pattern: Interest Rates and Equities

Note: IMHO, one of my best Trading Markets articles is scheduled for Friday publication. It deals with the psychological risks inherent in trading, even when you have a solid edge and good risk management.

In the wake of continuing rises in interest rates, I decided to look at what happens following two-day moves in the rate of the 10-year T Note. Going back to March, 2003 (N = 784), I found 116 instances of two-day periods in which the 10-year rate rose 2% or more. Three days later, the S&P 500 Index (SPY) was up by an average .26% (76 up, 40 down). This is stronger than the average three-day gain for SPY (.17%; 457 up, 327 down).

Interestingly, when the interest rates drop more than 2% in a two-day period (N = 102), the next three days in SPY average .03% (50 up, 52 down). This is distinctly weaker than average.

It thus appears that SPY tends to rise following drops in notes (rises in rates) and fall after rises in notes (drops in rates).

BUT - ever since we've started making new highs in interest rates, this relationship has broken down. Of the last six rises of 2% or more in rates, we've seen a weaker S&P three days later on five of those occasions. This suggests that the equity market may be responding to rising rates differently than it had from 2003-2005.