This past week we got to observe Fed Chair Jerome Powell and the US stock market and the US bond market do everything I said they would do in their complicated shuffle of ships-and-icebergs:
“I’m sure many helium-headed stock investors believe the lilly-livered Fed will turn tail and run from its goal of letting inflation rise as soon as bonds begin to clobber stocks more seriously…. I believe the Fed is more committed than ever to raising inflation as it has been saying it wanted to do for years.”
While bond yields had already begun to rise and compete against stocks, the Fed stayed the course, iceberg dead ahead. As a result, longterm bond interest rose even more because the Fed did nothing to jawbone the idea of increasing its bond-buying QE to take interest rates back down (which it accomplishes by purchasing US government bonds from banks to take them off the market, putting them on its own balance sheet).
You see, the Fed is — I believe — caught in its own catch-22. Usually, to lower interest (in order to stimulate the economy and hit the higher inflation number the Fed says it is targeting), the Fed would buy more bonds; however, buying bonds and adding them to its balance sheet tends to create more money in the system, and the bond market is already afraid of rising inflation because much of the new money is now going into the hands of average people. (This game only worked when all new money was going into the stock market.)
As a result, aiming for higher inflation by purchasing more bonds will cause the reinvigorated bond vigilantes to up their demand on bond yields to cover inflation, making it impossible to lower longterm yields by purchasing bonds.
The Fed’s old game isn’t working like it used to. My prediction for this March’s meeting of the Fed minds was that the Fed would do nothing because it is stuck. Or, as I put it,
The Fed, having realized way too late that it cannot ever unwind its balance sheet, may be reluctant to return to the full-on QE it formerly hoped it could actually unwind now that it knows it cannot…. The Fed doesn’t want to go higher faster than it already is if it can avoid it….
The Fed simply can’t stop; but, even at a rate of climb matching former periods of QE, bond interest rates have been rising vigorously, rather than sinking as they used to during former QE…. [Thus,] those interest rates will keep rising because the Fed clearly is not soaking up bonds fast enough to keep interest down even with the present strong QE support…. The bond vigilantes have the Federales encircled!
The Fed is caught between the rocks and an iceberg
… and that’s a hard place to be.
The Fed doesn’t want to do more QE anyway, but they also cannot do less. Thus, as Sven Henrich agrees below, the Fed can’t stop, and it has no end-game:
Henrich, noted as I do, that the Bond vigilantes did not let up from hammering the Fed over its decision at the FOMC meeting:
First let’s be clear Jay Powell’s maestro performance appears very much challenged at the time of this writing as the bond market appears to be openly challenging the Fed by producing new highs in yields:
As I was arguing, the Fed cannot stop interest rates from rising, even if it were to buy more bonds. Henrich illustrated that with the following graph:
That’s the bond market equivalent of dropping the hammer on the Fed’s happy narrative and risking losing the new [stock] market highs that ensued on the heels of Powell’s comments yesterday. Failed highs on charts never look pretty and risk a reversion trade of size especially as tech is once again under pressure in overnight following the renewed rise in yields.
Although the stock market actually shot up right after Powell’s press conference and bond rates relaxed for the remainder of the day, making it look like I was going to be wrong about rising bond rates killing the stock market in the weeks ahead, I can tell you with candor I had no concern. I felt completely confident the day’s moves would the very next day prove to be nothing more than a knee-jerk reaction of investors hitting the hopium, and both stock and bond investors would see the light with clearer heads by the next day. They did.
As one commentator on Seeking Alpha summarized that day and what would ensue, stocks shot up because …
the Fed gave the equity market exactly what it wanted, lower for as long as possible. Unfortunately, the bond market doesn’t seem as pleased, which will be horrible news for the stock market. Rising rates are crushing growth and technology stocks, and soon the rest of the market will follow because there are very few if any “cheap” sectors left in the market.
A force to be reckoned with
The NASDAQ has struggled excruciatingly against the backdrop of rising bond rates, and, after a week or so of reprieve earlier this month, it reverted back to that downtrend as a result of the past week’s FOMC meeting:
As Sven notes, what the NASDAQ does, as the former leader of the stock market, is now critical if it cannot continue to lead, as its failed recovery attempt indicates:
Because, like in 2000, if you lose tech you may eventually lose the entire market even though the market may pretend tech is no longer important.… And be clear: $SPX, $DJIA and $RUT making new highs while $NDX is clearly not is an important sign of divergence:
In 2000, that took six months or so to play out. However, we MAY have seen the start of the rest of the market capitulating at the end of the week as the Dow and S&P both, in my opinion, seemed to realize the bond vigilantes are serious and are in the game to stay. The Dow plunged pretty significantly on Thursday and Friday as cooler heads digested the Fed meeting.
MarketWatch, reported the end-of-week event this way:
Zero Hedge reported it this way:
It’s been a familiar pattern for most of the past year: Newbie investors chasing upside in single stocks as professional money managers position for more trouble. This month, the sentiment gap between these groups has all but disappeared.
Blame that on a selloff in tech high-fliers popular among amateur investors and a widening rotation into value names.
You can dream all you want, as many do, about how the volatility of the last couple of weeks is just a rotation from growth stocks into value stocks; but I think we have a much bigger change in play here, and the downdraft of the leaders (the tech stocks that dominate the NASDAQ) will suck the overall market down like a sinking ship takes down swimmers that are too near its disappearing hull.
Or, as Barclay’s phrased it in more technical terms:
The equity selloff had a larger impact on retail investors as large-cap tech/growth stocks which generally overlap with retail favorites took a bigger hit, relative to other sectors….
A sinking ship drowns all life boats
That is the gist of it. The downdraft in the wake of the hugely overbought tech stocks that are sinking is a much bigger flow than is likely to be offset by the buoyancy of prices in value stocks. That is, in part, because some of the outflow from tech will now go into higher-yielding, safer bonds now that bonds are waking up from their decadal sleep (not to be mistaken with bond funds that are full of lower-yielding bonds at this point, so may lose investor money — one of the major weirdnesses of the supposedly safe-haven yet highly speculative bond market).
How deeply the rising yields in bonds will tear into the stock market at this point, I won’t say because there are so many government and Fed stimulus lifeboats floating around that would normally cause the stock market to rise.
So, we’re caught in a complex interplay of competing forces. It’s not going to be an easy course to predict or navigate, but my primary thesis is that Fed effectiveness is falling apart because the costs of its interventions (interest and inflation) are weighing heavily against the benefits. (In other words, the Law of Diminishing returns is on the downside of its curve now for the benefits of Fed stimulus actions.)
ZH, in the article above, referred to this interplay between stocks and bonds as
a sea-change from a long-term pattern
You see, it is not just bond competition that is syphoning money out of stocks, but that new dynamic between bonds and stocks is also having its own impact on the risk appetite (i.e., sentiment) of the newbie players that came to dominate the stock market in 2020 — the Reddit Raiders and the Robinhood crowd:
As bullish sentiment among retail traders faded during a rout, so did newbie traders’ participation. As yields rose and the Nasdaq 100 plunged into a correction, retail traders stepped back and trading activity among institutional investors topped retail for the first time since May 2020.
Also, as I noted in my earlier articles, bond yields aren’t likely to swamp stocks with too much savagery until the ten-year hits 2%.
The newbies may regroup after they figure out what is happening here and the cheerleaders like Dave Portnoy take them on new adventures into value stocks; however, we’ve seen many times in history how the worst market crashes happen on the backs of the newbies as the older “smart money” sells into their vain, testosterone-fueled enthusiasm (sentiment) and lets them take the losses.
I’ve warned before about how often the ecstatic newcomers, who have bragged about how easy they suddenly discovered it was to make big money in stocks, become the ready stooges the smart money sells to on the way out the back door. That’s how “old money” gets to be old money.
The treasury’s ship is breaking apart
Yields are rising, prices are falling. One of the areas that Powell was completely silent about — vocally silent about by stating the Fed will wait to deal with it later — is a Fed restraint on banks called SLR, which controls how much of a bank’s reserves can be held in treasuries.
To support all the COVID stimulus last year, the Fed removed the restraint last April, but that moratorium on the restraint, is set to expire this month, and that is where the sell-off in treasuries resulted in falling prices for existing bonds — a.k.a, rising yields on all bonds — back in February:
A chaotic selloff in the Treasuries market was spurred by a massive exodus from popular trades, heightened by liquidity concerns that could inflict more pain in coming days. The exodus happened at a time when traders were already worried about the imminent disappearance of a support beam for the market — a regulatory exemption that has allowed banks to accumulate more U.S. bonds.
Treasury futures open interest across a range of maturities sank by a huge amount Thursday: the equivalent of $50 billion of 10-year notes. It didn’t help that this coincided with the Treasury Department selling $62 billion of seven-year notes, an auction that proved to be a disaster….
Back in April, the Federal Reserve tweaked its rules to exempt Treasuries from banks’ supplementary leverage ratios — allowing them to expand their balance sheets with U.S. debt. But that relief ends March 31 and what happens next is something of a mystery.
For now, the Fed chose to keep it a mystery; but this is where the bond vigilantes have, as I said in my last article, their guns in the Fed’s back. The noted disaster in treasury auctions will become much worse down the road if the Fed allows the SLR moratorium they have in place to end in March.
First, banks will be forced to sell treasuries at the same time the federal government is emptying its massive Fed bank account of money in the form of stimulus checks. The confluence of these two large cash flows could create a lot of monetary turbulence, which could become even more disorderly than what we’ve already seen:
“It wasn’t an orderly selloff and certainly didn’t appear to be driven by any obvious fundamental continuation or extension of the reflation thesis,” wrote NatWest Markets strategist Blake Gwinn
Later, if the federal government’s big infrastructure stimulus programs are approved, the government will no longer have those banks that just tried to reduce their bond holdings to sell bonds to in order to fund the programs. The Fed may, then, have to suddenly reverse itself on the SLR moratorium, and the Fed doesn’t like losing face that way, even though it keeps losing face in major ways as it did with its original unwinding of its balance sheet and the 2018 stock crash and 2019 repo crisis pileup that it created until it fully reversed course.
In short, it’s all getting more complicated, and the Fed’s ability to navigate is being constrained. To put it in blunt but appropriate terms, the Fed is the market’s bitch right now. When the Fed finally does raise its interest targets, it will be merely to try to get back to looking like it controls the financial market, instead of the market controlling it. It will, in other words, just be matching its targets to what the marketplace has already done.
Or, as another Seeking Alpha commentator called it,
If the Fed wants to hold yields down, they will have to actually do something. They did not follow this course. They made numerous statements, but any actual action was missing from the pronouncements. Words alone were not enough to hold rates intact, as I suggested would likely be the case.
The commentator applied the same metaphor I did in my article last week:
Pretty tough to control the crowd with words when the rest of the boys have a loaded pistol near at hand.
The fact that things are not responding to mere Fedspeak and are even doing the opposite of what Fedspeak is intended to accomplish is, I think, partially why the Fed put off dealing with the SLR situation … twice. It didn’t want the news about that to upset what was already considered a nearly impossible situation for Powell’s announcements last week.
I think an even greater factor is that the Fed is reluctant to take action that it will likely have to reverse, making itself look even more incompetent, just as it had to do to end the Repocalypse it created.
I posit the SLR situation is serious enough and difficult enough that the Fed decided it merited a meeting of its own and an announcement of its own, or it would overshadow anything the Fed did and announced last week.
As noted in the Newsmax article, US treasures saw record low demand in a recent auction of seven-year bonds. They’ll see much lower demand if banks are no longer buying due to the reinstatement of SLR restrictions AND the resulting offloading of those treasuries the banks already have at the same time. So, the Fed needs to massage this through … or keep the SLR moratorium in place for a much longer time as the government looks to be needing more banks to buy for the foreseeable future, not less.
While the Fed may want to end its SLR moratorium, doing so could crash the bond market, which is far bigger than the stock market but which would also crash the stock market by sending longterm yields soaring, making bonds all the more competitive to stocks.
(Falling bond prices means the same thing as those who already own bonds or who want to issue new bonds having to offer higher yields to investors. One can also look at it this way: when bond prices plummet, it becomes more attractive for people to take money out of stocks in order to scoop up bonds — existing or new issuance — at bargain prices.)
Rising bond yields are damaging to stocks for a number of other reasons as well:
It may be dawning upon the markets what the costs of higher interest rates will do to not just the yields of Treasuries, but the yields of mortgages, corporate borrowing, bank loans and other credit-related instruments. The price to pay for higher yields is not just confined to the Treasury markets, I can assure you.
Even so …
For whatever reason – and it certainly may be because they simply have no idea how dire the consequences would be, it now appears that there is a full-court press by the administration and Democrat politicians to not renew the SLR and unless the Fed steps in and overrides this, brace for impact as banks will have no choice but to dump tens of billions of holdings into the open market sparking the next full-blown crash as first yields soar and then all high-duration stocks, i.e., growth names, crater.
As always, the Fed has no end game
As Sven said, “What’s the end game here?” (And as I’ve often said, “The Fed has no end game.” The Fed just keeps boxing itself in tighter with all of its interventions.
Back in February,
the selling was triggered after a U.S. auction of seven-year bonds saw record low demand. The bid-to-cover ratio — a gauge of investor interest — came in at 2.04, well below the recent average of 2.35. That sent five-year yields surging through 0.75%, a crucial technical level watched by investors as a signal that any bond selloff could worsen.
The Fed’s solution for all the market distortions that are starting to gang up against it has been either to attempt to back away from its interventions and then fail at backing away from its interventions so it has to jump right back to more of the same … or to kick the can further down the road, which avoids the unresolvable problems for now at the cost of making them worse in the future.
The bind the Fed is in is getting outwardly and obviously dangerous:
The yield spike sent traders scurrying to manage their positions…. Preliminary open interest in Treasury futures across the curve — a measure of outstanding positions — collapsed by an amount equivalent to $50 billion in benchmark 10-year notes.
As Fed interventions pile up, so does the difficulty of managing their side effects.
“We think that a steep decline in market depth contributed to the outsized moves in yields,” wrote JPMorgan Chase & Co. strategist Jay Barry…. Bond traders were already on edge as they waited for Fed guidance ahead of next month’s expiry of a regulation that has encouraged banks to buy Treasuries [the SLR moratorium]. Neither Powell nor Randal Quarles, the vice chair for supervision, gave an answer as to whether the measure would be extended, which likely helped extend a clearing of positions in the swaps market.
That was all written in late February, and the Fed made the same punt this past week.
Credit Suisse strategist Zoltan Pozsar said clarity on this situation is one of the things needed to calm long-term Treasury yields.
Investors didn’t get that … again … in March, and so the treasury sell-off picked up pace after the March meeting.
Treasury tightens the Fed’s room to navigate
And the challenge isn’t being made any easier by former Fed chair Janet Yellen, now the US treasurer.
The Fed attempts to maintain control of various rates (including inflation, unemployment and long-term interest rates) through its monetary policy decisions. In the past, poor choices arguably led to both the dot-com bubble and the Great Recession….
Powell has to balance economic recovery and employment against market bubbles and excessive inflation. That’s a lot of balls in the air… What if one drops…?
Enter Treasury Secretary Janet Yellen, who just threw a big monkey wrench in Powell’s plans to maintain any semblance of tight control over rates….
The Treasury is planning to “unleash what Credit Suisse Group AG analyst Zoltan Pozsar calls a ‘tsunami’ of reserves into the financial system and on to the Fed’s balance sheet….”
Excess money supply causes inflation. And the official cash balance sheet at the Treasury is about to fall by hundreds of billions of dollars as they flood the market with cash
For the present round of stimulus, you see, the government has already borrowed all the money it needs, which it has started pumping out as cash into the hand’s of ordinary “consumers” — you and me. Yet, it’s future programs, such as the much-talked-about infrastructure programs, will require even more borrowing.
Last summer, the Wall Street Journal noted,
When bubbles burst or markets spiral downward, the Fed suddenly comes around to the idea that markets aren’t so rational and self-correcting and that it is the Fed’s job to second-guess them by lending copiously when nobody else will.
In essence, the Fed has adopted a strategy that works like a one-way ratchet, providing a floor for stock and bond prices but never a ceiling. The result in part has been a series of financial crises, each requiring a bigger bailout than the last. But when the storm finally passes and it’s time to begin sopping up all that emergency credit, the Fed inevitably caves in to pressure from Wall Street, the White House, business leaders and unions and conjures up some rationalization for keeping the party going.
Testifying Tuesday before the Senate Banking Committee, Fed Chair Jerome H. Powell was pressed on that very point by Sen. Patrick J. Toomey (R-Pa.), who asked why the Fed was continuing to intervene in credit markets that are working just fine.
“If market functioning continues to improve, then we’re happy to slow or even stop the purchases,” Powell replied, never mentioning the possibility of selling off the bonds already bought.
What Powell knows better than anyone is that the moment the Fed makes any such announcement, it will trigger a sharp sell-off by investors who have become addicted to monetary stimulus.
On and on the market dysfunction goes, and I’m not saying the party is going to suddenly come to an end. I’m just saying that the Fed’s number of problems that it is managing is getting endlessly bigger with each intervention, and the Fed is appearing to do, as I said last spring would be the case in the present crisis, worse and worse at keeping all the plates spinning.
I don’t expect any market is going to give up quickly here, but clearly the fight is on in the bond market between Feds and vigilantes and between the bond market and the stock market, which is all to say, it’s looking, so far, exactly like I expected it would look after the Fed’s March meeting.
The chaos will continue until things fall apart
The stock market will be the last to see it coming, so probably the first to break. The bond market seems to have already seen, at least, one major iceberg dead ahead — inflation.
Short-term interest rates are likely to fall due to Yellen’s treasury dumping so much cash from the government’s bank account into the bank accounts of all tax payers this month, while longterm yields continue to rise due to inflation expectations from all that cash, steepening the yield curve. At short end of the yield curve, some analysts even expect short-term rates to go negative again.
The complications are everywhere. As I noted in my last article,
The market is raising interest on its own. The Fed won’t be thinking about increasing interest to cool inflation. It will be thinking about how to keep interest down and let inflation run a little hot.
That is exactly what we saw play out at the Fed’s March meeting and its aftermath. Even as the Fed kept a solid aim on allowing more inflation as the core of its meeting press statement, it saw longterm interest rates shoot up the day after the statement due to fear of inflation.
The purpose of letting inflation run hot isn’t supposedly for inflation’s sake! It’s to allow longer stimulation of the economy via low interest rates for longer. Instead, the Fed’s announcement caused interest rates to rise; so, nothing gained. That’s exactly what being stuck looks like!
Many, including Goldman Sachs, thought the Fed, at its March meeting last week, would hint at earlier interest-rate increases than it had been indicating. It did not. It held firm, as I was certain it would do, but to no avail. As I wrote at the start of the week,
A world bloated on debt has no stomach for even marginally higher interest.
We saw at Jerome Powell’s press conference following this past week’s March meeting of the Federal Open Market Committee, which attempts to steer the entire US economy under Fed monetary management, that the Fed did not shrink from its plan of creating more inflation at all.
However, we also saw that the bond vigilantes did not shrink from unloading their guns into Powell’s backside …
as 10-year TSY yields briefly touched 1.75% this morning in the wake of Wednesday’s FOMC…. As a reminder, Bank of America warned that 10-year yields at 1.75% was the level where correlations between risky assets and rates begin to change empirically, and 10-year yields above that level could become a headwind for the equity complex.
I also noted in my last article,
It looks like we are entering those times I said were coming when the plate spinner can’t keep everything spinning and up in the air…. Nevertheless, I expect at this week’s Fed meeting, Powell will tell everyone that he hasn’t any concern about inflation or interest, but just remember he’s got a gun in his back.
As I figured, Powell was completely sanguine about inflation, but the markets (both stocks and bonds) reacted strongly, and the aftershocks are still playing through. Concluded Newsmax:
Negative short-term interest rates could be only the tip of the iceberg. We just might be looking at the end of what Bloomberg called “the everything bubble….” Powell and Yellen might be steering the U.S. economy straight into the iceberg.
We might, indeed, see the end of the Everything Bubble. Behold the Titanic. Behold the iceberg.
And now for something totally ridiculous
I’ll close with this complexly ditzy comment of the week about the FOMC meeting and Powell’s press conference where the credit for lame ignorance goes to Crazy Cramer:
Man, Powell is such a hitter. He is relentless in his desire to help the underclass in this country. More than anyone. It’s truly incredible… and joyous!
— Jim Cramer (@jimcramer) March 17, 2021
You have to be both dishonest and retarded to believe that. As Henrich points out, what the Fed has done for the past decade for the underclass looks exactly like this:
Only Cramer could say something so stupid and so sold out to Wall Street. Joyous times, indeed, for Cramer and his cohorts at the top.