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The S&P 500 closed at a four-year high yesterday. And why not? Earnings are up and bond yields are down. That’s your formula for higher stock prices.

There’s little reason to believe that bond yields are headed higher. That’s what ended the rally earlier this year, but now it’s clear that inflation has been tamed. Even though oil has headed up, it hasn’t translated into across-the-board higher prices for consumers. In fact, higher equity prices might be a sign that oil is headed lower.

What will be interesting to watch is the future of short-term interest rates. Although the Fed has raised rates nine times so far, the yield on three-month Treasury bills is lower than the Fed Funds rate. This may mean that the market is getting uncomfortable with these rate increases. The futures market expects two more rate increases this year.

Posted by edelfenbein at July 15, 2005 8:56 AM