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Are Interest Rates About to Spike Again?

In the top panel of the chart below, you'll notice that the Morgan Stanley Cyclicals Index is hitting new multi-year highs relative to the S&P 500. At the same time, in the bottom panel you can see that 10-year Treasury yields have not been following cyclicals higher over the past few weeks. This divergent behavior is unlikely to persist.

If cyclicals are correct, we should start to see the tide of weaker-than-expected economic data turn. The next major test will be this Friday with the report of non-farm payrolls. The current expectation is for 150,000 new jobs, which would be a significant improvement from the December (75,000) and January (113,000) numbers.

If we see a sizable beat to these expectations, I would expect long duration bonds such as the iShares Barclays 20+ year Treasury ETF (TLT) to get crushed, with yields spiking higher. Currently, I view this as the more likely scenario as many of the important intermarket relationships I track are pointing to a continued risk-on environment.

However, if the report comes in below expectations, it will be difficult to continue to use weather as an excuse as expectations should have been lowered by now to account for colder weather. In this case, market participants may begin to wonder if bonds were right all along, and cyclicals could decline to resync down with bond yields.

It should be an interesting Friday morning, particularly in the bond market.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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