Bond Market’s Yield Curves to Fed: “Get your ass in gear”
It is an indication from the bond market’s Yield Curves implying a dovish Fed to come. But the Fed will sit on its ample behind for as long as it takes for it to finally act on the message.
Eventually the Fed will be dragged into action; dovish action. Much like the Fed was compelled, despite its tardiness, to finally fight inflation with hawkish action on the last cycle, as we noted in real time back in that phase.
The inflation problem, that is, the effects of the inflation problem created by the Fed and government in 2020, could have been less severe had the Fed gotten off its ass and addressed the problem sooner. Instead, it held off in paranoid fashion until it was sure the asset bubble in equities it was blowing was in full flight.
Was this political? I can’t comment. But the inflation was birthed under Trump and it was sustained way too long under Biden (with Janet Yellen riding in the side car as Treasury secretary).
Fast forward to today. CME Group, which I have come to realize is not the skilled forward prognosticating entity many think it is (it all too often reacts to events and indications in real time), sees a 70% chance of a Fed Funds rate hold in May.
Although CME sees an 87% chance of a cut by one or two basis points in June.
On April 7th we noted that the Yield Curves were painting the Fed “behind the curve”. That was due to the 10yr-3mo curve lagging the 10yr-2yr. On April 9th we reviewed the Yield Curve steepener, indicating an economic bust in the not too distant future.
Proof, you demand? Here it is.
Historically, Yield Curve steepeners have never failed to bring on recessions to one degree or another at some point, usually after the steepener has expressed itself for several months. The current steepener need not necessarily bring on a recession just yet. But it is very likely coming. The shaded areas on the chart were the recessions of yore.
The yield curve anchored by the 3 month T-bill is more heavily influenced by the Fed’s status (holding), and the curve anchored by the 2 year Treasury note is more subject to a freer * bond market.
The 10yr-3mo is re-steepening to un-inverted this morning (Friday).
While the Yield Curve anchored by the 2 year Treasury Note continues on its steepening way. It is dragging the chart directly above into the fight and thus, it is dragging the Fed into the fight.
The concept of short-term Treasury yields declining in relation to longer-term Treasury yields (the definition of a curve steepener) means gathering risk-off sentiment in the markets (well, that’s been obvious even to those who don’t know what a yield curve is) as capital flies toward the safest liquidity in short-term Treasuries and T-bills.
This is not a discussion about gold, the ultimate risk-off asset in times of liquidity stress. Gold is and has been just fine, when it was languishing below 1100/oz. a few years ago and when it is booming to new highs today. It is insurance and safety in a way that bonds, the debt of sovereign nations at economic war, are not.
Insofar as we are discussing bonds, this is the kind of pressure that will drag the Fed into action, probably whenever the current stock market rally (favored view is that it is a bear market rally) ends.
* Notice I did not write “free” bond market? Bond manipulation has been tradition in Modern Monetary Theory (MMT), or as a call it, Total Market Manipulation (TMM).
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Gary, I still follow your writings, and thank you for sanity in this craziness. I am literally ~8 months from retirement, I decided on Dec 31 this year. My question to you is about bonds. Not treasury bonds, but generic, investment grade corporate bonds (of which I have a bunch). Under the assumption that faith in the US continues to decline, and LT treasury yields continue up, do corporate bond yields (and therefore dropping underlying value) have to follow? It would seem if investors lose faith in US bonds, that would not necessarily mean they’ve lost faith in, for example, Apple bonds or Exxon bonds. Can one generally expect that since US bond yields rise, corporate yields must rise as well, or not necessarily?
Well Mike, even though I see it as all part of the same unraveling enchilada, there is rationale that the Republicans will bail out corporations through tax welfare. I also expect Treasuries to stabilize and head higher as the economy soils itself. But longer-term all bonds are probably at risk. The only bonds I hold now are 0-3 year Treasury (took a loss on TLT spec). But I may creep the Treasury curve a little further out when I think the recession is clear and present. No personal interest in corporates, munis or any of that crap in an economic bust. But that’s just me. I don’t care about maximizing income. I care about preservation of capital, letting the counter-cyclical gold stock sector do the spec for gains.
Thanks, Gary. I have definitely found that everyone has their own unique investing style. Mine currently is bonds, gold, cash and a tiny sliver of the market in that order. Hopefully that provides income and preservation, and sleep at night!
Absolutely. If you don’t have a style you believe in you become a leave blowing the chaotic winds of fate. That sounds pretty philosophical.