The Rising 2-Year U.S. Treasury Note Yield And A Weaker Dollar Will Push The S&P 500 Index Towards 3,000

The S&P 500 index (NYSEARCA: SPY) closed at another all-time high of 2,602.42 on Friday, while the correlation between the index and the yield of the 2-year U.S. Treasury Note over 200-day period rose to +0.90, meaning the S&P 500 and the 2-year yield move in the same direction, up or down, where +1.0 is a perfect positive correlation. The correlation between the S&P 500 and the 2-year yield has steadily increased since mid-November 2016 after the U.S. elections and reached its peak at about +0.91 in late July, before making a small pullback.

Arguably, the strong correlation between the S&P 500 and the yield of 2-year U.S. Treasury Notes is consistent with what one expects if investors sell 2-year U.S. Treasury Notes as funding to buy S&P 500 shares. In rising interest rate environments, one is expected to sell short-term Treasury notes and buy long-term Treasury bonds, which are influenced more by growth and inflation expectations and less by rising interest rates. However, that was before the Fed's plan to reduce its balance sheet, which may cause yields of long-term bonds to rise over time as the private sector is forced to absorb an increasing share of Treasuries.

An inverse correlation between the S&P 500 and the U.S. dollar index (NYSEARCA: UUP) over a 200-day period emerged in early July, while the S&P 500 bounced off the 2,420 level. In August, Credit Suisse said in a note that a weaker U.S. dollar should be another... Read more