STRATEGY: Rates possibly peaking is 1 of 4 reasons the “bond hawks” are winning this battle, but losing the war
Policymakers recognizing COVID-19 isn’t a crisis at this point…
Absent a new and worrisome variant emergence, COVID-19 is diminishing drastically across the US. The pace of this retreat is lightning fast and has even prompted policymakers to acknowledge that it may be time to consider the phase where “covid isn’t a crisis”
- practically speaking, this is great news for all Americans
- at the back of my mind, I am aware variants can emerge
STRATEGY: Rates possibly peaking is 1 of 4 reasons the “bond hawks” are winning this battle, but losing the war
In case you missed it, on Wed evening, Mark Newton, Head of Technical Strategy at FSInsight, comments about rates were eye opening. Check out the headline below:
- basically, Mark is noting he thinks interest rates will peak in March
- and head lower
As we know, the rise in rates has been sending increasingly large ripples of panic across equity markets. Thus, a peak in rates is a big deal. Big deal.
I asked our Head of Technical Strategy about this, and he believes the 10-yr will hit resistance around 2.2% or 2.3%
- basically, he sees rates peaking not too much higher than current levels
- even in the midst of the selling yesterday, the 10-yr yield actually fell
If Newton’s view is correct, the reversal lower in rates will be a positive for risk assets.
Second, Fed Fund futures historically too hawkish, thus, if market consensus is 7 hikes, that is “several hikes too many.” Another factor weighing on stocks has been the accelerating “hike forecasts” by economists. As shown below, another investment bank is calling for 7 hikes in 2022, above the current 6 priced in by the Fed fund futures market.
But take a look at the historical accuracy of Fed Funds futures markets. This is data compiled by our data science team, led by tireless Ken. As shown:
- from 2009 to 2016
- Fed fund futures markets
- chronically overshot how many hikes the Fed would do
Are we are “max hike hysteria”? Maybe. It really depends on the forward path of inflation.
Third, vehicle prices might be apexing in the US, both used and new and that will be “deflationary”
Autos have accounted for 50% of the rise in CPI. And there are signs that auto prices may be cooling, as production is catching up with demand. In fact, JPMorgan economists note that vehicle prices could actually decline. In fact, while they lay out a range of scenarios, a key consideration is this: – if auto prices are “flat”
- CPI impact is 0% inflation
- Autos new and used added +1.97% to CPI in 2021
- thus, that is a massive swing
- if prices fall outright
- this is deflation
- JPMorgan even posited prices could fall 20%
- this would be -1% CPI, or a massive 300bp swing
As shown below, of the +397bp increase in CPI, cars were half of that, or +193bp
Fourth, Russia/Ukraine 5 of 5 times, markets “sell the buildup, buy the invasion” –> markets bottom just before guns are fired
The armed conflict is underway in Russia/Ukraine. Hundreds of explosions have been detected by observers and Russia has now sent buses to evacuate citizens in Donbas and Lufhansk. While we do not know the extent of this hostility, there is an adage about wartime. I first heard this from an Atlanta-based client around the 2001 Afghan conflict:
- “sell the buildup, buy the invasion”
- meaning, markets sell off into the risk of conflict
- and stabilize once the conflict starts
If one listens to pundits, many are advising to stay “risk-off” because there is little visibility on the extent of the conflict. But this is not what history suggests.
Take a look below. We highlighted the 5 most recent armed conflicts that impacted markets broadly.
- 5 of 5 times
- stocks bottomed at the invasion or just before the invasion
This is counter to what many think. In fact, many might logically believe that uncertainty from conflict means “risk off” until the conflict ends. This is not the case.
BOTTOM LINE: Bond hawks are winning this battle but losing the war
We think there is growing tension between what bond market complex (hedge funds, bond managers, investment banks) and what the stock market wants. That is, credit markets want a recession, so interest rates can fall, leading to a recovery in bond prices. This is something we will highlight in upcoming reports.
- while markets are roiled by the dual issues of Fed hikes + Russia/Ukraine
- we think investors are overly pessimistic
We still see upside to stocks before month-end.
…Bonds and stocks want a different outcome
Hence, there is structural argument for why the bond market wants the Fed to tighten. The bond market complex suffers from higher rates:
- the bond complex is
- investment banks
- credit investors,
- hedge fund managers
See the grid below. Under 4 possible inflation and real interest rate scenarios, bonds perform poorly in 3 of 4. In other words, the bond market prefers:
- falling inflation
- falling interest rates
- which usually happens in a recession
In short, the bond market is clamoring for a recession. And stocks obviously are better off with robust GDP growth. Thus, the bond market and stock market want different things. The Fed is arguably more bullied by the bond market than stock market. Hence, the Fed is being pushed to tighten.
…under “guaranteed TINA” there is $53 trillion of bonds that likely see re-allocation
We have mentioned this notion of “guaranteed TINA” or guaranteed there is no alternative. The reason for this view is that under a scenario of strengthening global economy and normalizing inflation, bonds are likely to deliver negative returns. What many investors may not appreciate is that there is a massive holding of bonds by US households. Our data science team, led by tireless Ken, pulled together the estimated holdings of bonds in the US. Take a look at the table below:
- US household net worth is $145 trillion
- US households own $53 trillion in bonds
- 37% of assets
These $53 trillion is likely to deliver negative real returns for the foreseeable future. If inflation strengthens, bad. If real rates rise, bad. If Fed hikes, bad. Only a recession really helps this position. And makes bonds look better than stocks.
- in a way, this is why the bond market is clamoring for Fed hikes
- Fed hike slow economy
- might tip US into recession
- bonds rally
…Is market too worried about inflation? Deep Macro, the macro research firm, thinks inflation already past peak
From time to time, we like to cite work by Jeff Young, founder of Deep Macro research. They use alterative datasets to gain some lead time on key economic indicators. Their latest report is interesting. They highlight multiple reasons why they see US inflation, measured as CPI peaking. There are 4 in their report, but I want to highlight two of the keys.
First, as shown below, the broad measures of inflation are rolling over:
- producer prices
- trader
- inflation sentiment
But CPI is still rising. CPI, as Young points out, is a lagging indicator:
- The Fed looks at CPI
- CPI lags producer prices
- PPI is peaking
Hence, US inflation should be cooling. Yet, the Fed is talking about tightening because of a “hot Jan CPI”
- is this a policy error in the making?
- the future is uncertain
Similarly, wait times for truck drivers is collapsing
Deep Macro also shows the collapse in waiting times for truck drivers:
- collapse in Newark, Miami, Houston and Savannah
- down in CA but not collapsing
- is this due to CA maintaining overly strict protocols?
If this data is to be correct, there are two implications:
- supply chain tightness is easing
- COVID-19 protocols are contributing to tightness
- as COVID-19 eases
- inflationary pressures cool
Hmmm… this argues the Fed talk of 50bp is simply a result of the bond market being a bully.
Figure: Themes in 2022 – “BEEF”
Per FSInsight
Figure: FSInsight Portfolio Strategy Summary – Relative to S&P 500
** Performance is calculated since strategy introduction, 1/10/2019
