Excerpted from the Market Internals segment of this week’s Notes From the Rabbit Hole, NFTRH 522. The segment focused on the bond market and its macro signaling this week. There was more to the segment, including US and global negative divergences in play to long-term yields (positive divergences for bonds) despite the bullish technical situation, and some possible implications/downside targets for the stock market.
Treasury Bonds and the Fed
The technical signs [of a potential bond bear market/breakout in yields] are there, but…
…the yield has not done anything yet that it did not do in 2007, 2009, 2010 and 2011 before failure back below the red line. I remember the 2011 and 2013 highs especially as being very noisy. 2011 saw none other than the “BOND KING” shorting the long bond and 2013 was the well orchestrated Great Promotion Rotation (out of bonds and into stocks) that the media shoved down our throats all year before the Q4 2014 stock market weakness that eventually rolled into the 2015-2016 correction and Brexit and global NIRP (negative interest rates) hysterias.
So, is it different this time? I will never blindly extrapolate history into the future. It could be different this time and the fact that the economy is now running on fiscal policy as opposed to years of monetary policy could do the trick. But one group is decidedly not set up for a continued rise in 30yr yields (our target is 3.5% based on the daily chart pattern). That group is the Commercial Hedgers, which are usually the ‘smart money’ at turning points. Hedgers’ positioning is anything but hedged. It is full contrarian bull to a historical degree. I don’t will the charts into existence. I just respect their messages.
Chart source: Sentimentrader.com
What happens if global yields pull back and leave the US with all those bond bears convinced of a new bond bear market? What if it eventually proves to be a garden variety failed breakout on 30yr and 10yr yields, and the Yield Curve starts to steepen under pains of disinflationary forces so predictably, as it did in 2000-2002 and in 2007-2009?
In other words, what if we are thinking too hard about inflation being the driver and out-thinking ourselves with respect to this moment being the big one, the big macro change as would be indicated by a real breakout in long-term yields and bond bear market? The system has been in a macro wash-rinse-repeat cycle of inflationary excess resolved by deflationary liquidation, which then sows the seeds of the next inflationary excess.
The Fed is staying the course against inflation and if you were to sit at a bar with me on one of those rare occasions when I have my tin foil hat on, you might get some off hand commentary about what I think may be in play.
You’d have to buy me a bourbon first, and then I’d talk about how I think that hyper inflation would end the Fed as the currency it supposedly stewards would go up in flames. I would talk about how the Fed, being an animal – like the rest of us – with self-preservation instincts is not going to fall on its own sword.
Trump may have picked Jerome Powell as Fed Chairman, but Powell was already of the Fed and there were not going to be any candidates available to Trump that were not of the Fed. Men who stare at charts once again know that bonds are entering a bear market. But let’s just tap the breaks on what everyone thinks they know.
Trump is fiscally pumping the economy. That is what is different. The Obama administration fiscally burdened the economy. The Fed was ultra accommodative then but is balancing the scales in reverse today. It makes perfect sense, but in my opinion the Fed does not care about you or I… or Trump or Obama for that matter. It cares about maintaining its power through the decades of up and down cycles.
It can be strongly argued that the Fed knows it needs a market liquidation to not only tamp inflation prospects but more importantly to support the bond market, which has been the funding mechanism and inflationary policy re-loader since Paul Volcker “whipped” inflation.
So what is the trigger? The Fed is raising the Funds rate and also slowly expiring QE. Both of these things are compatible with currently rising long-term interest rates. But at some point a critical mass of policy tightening would theoretically rein the herds back in to the liquidity of Treasury instruments, first to T Bills and then if risk really goes ‘off’ in bloated financial markets, long-term bonds and notes. So I for one will be interested to see if this break above the 30 year yield’s limiter is real this time or Memorex yet again.
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