What a Week: Clouds Part

The strongest day in the stock market came Wednesday at Bernanke's now-practiced beckoning. Instead of saying that "additional firming" will depend on incoming data, the Fed said that "future policy adjustments" will depend on incoming information.

Traders at first interpreted the more neutral tone to mean that rate cuts were coming down the pike. The fed funds futures market immediately priced in a 40% chance of a rate cut in June, up from 24% before the statement, though the odds reversed later in the week to pre-FOMC statement levels.

But for August, that market now marks 85% odds of a rate cut, up from 65% prior to the release of the Fed's statement.

The yield curve, which has been inverted for months between two-year Treasury notes and 10-year and 30-year bonds, finally normalized after the FOMC statement. It ended the week flatter, as the yield on the two-year and 10-year notes both ended at 4.61%. The 30-year bond yielded 4.80% on Friday.

The Fed's words did draw out some bond market vigilantes worried about inflation to drive up yields on the 10- and 30-year bonds.

But, bond traders were also following the stock market's lead, says Bianco, as Treasury traders started to believe in a stronger economy. According to Bianco, the 10-year Treasury yield has a 70.8% correlation to the S&P 500. So, in the S&P's best week in four years, the bond market took notice.