The Everything Bubble is bursting, and the Fed has barely even begun its war on inflation. Many top stocks are already in their own bear markets. Nvidia, way off its game, has lost 25% of its value from its last high score. The ridiculously skyrocketing Tesla has plunged back toward earth’s gravity on a trajectory that has lost 28% of its high-orbit altitude. Facebook (now transrendered as “Meta”) has done a face plant near bear territory, down 17%, as has Amazon, slithering down 16%. These are the market leaders that I’ve said would fall the hardest during the developing collapse.
Following such high-tech trends, the QQQ and the NASDAQ have busted below their lower support trend lines, and the NASDAQ has plunged well below its 200-day moving average:
More than 50% of NASDAQ stocks are in bear markets. The average NASDAQ stock is down 38%! The total index, itself, is already in full correction (down by more than 10%).
Goldman Sachs led the present slide in the reporting season for the fourth quarter of last year when the massive bank got sledge-hammered after its earnings report, diving 7% in one day to where it has now lost 8.5% of the company’s value.
The taper tantrum is here
“The Problem?” asks one analyst…
The Fed taper has started, earnings have been disappointing to start the year, momentum and technical conditions continue to weaken, and possibly the most significant factor is that valuations are still very high.
First on his list: the Fed taper has started, and that taper still has a long way to go. Everyone is saying it now. That thing that I predicted would kill stocks — the Fed’s taper being rapidly accelerated by inflation — has arrived, and it’s decimating stocks already by doing exactly what I’ve said it will do — releasing bonds from the Fed’s steely grip so they can finally price for inflation. That last bit being the key blindspot that I said almost no one in these markets was understanding.
Looking at what is happening in combined stock and bond prices (inverse of bond yields), they haven’t fallen in unison this hard since last March:
If you maintain the old standard 60-40 stocks-to-bonds portfolio, you’ve lost money in thirteen of the last fifteen days. For bond traders holding ten-year treasuries, this has been the worst start of a year in three decades!
With all this, how is that long-languishing market volatility doing? Well, for the NASDAQ, it’s suddenly getting up there again:
Measured in another broader way, volatility in stocks right now is looking like it did in the early days of the dot-com bust:
And we’re just getting started because, as I laid out in my most recent thank-you post for those who support my writing, the Fed is still adding liquidity to markets like there is no tomorrow. While it is already halfway through its tapering, “tapering” only means it has slowed down in how rapidly it is adding QE. The Fed is still doing as much QE as it did at its various peaks anytime since the Financial Crisis that put us into the Great Recession, which I will show further down below.
The bond vigilantes are back
Just backing off on Fed bond purchases has already released the bond vigilantes:
The Rates Vigilantes are at the gates and are now pushing through / above 4 hikes in ’22…and with more trending.… The Fed will simply “have to” take what the market is dictating to them, despite me currently believing that the FOMC has little desire to do-so.
Nomura via Zero Hedge
That is what “bond vigilantes” do. What the term represents is bond investors taking the lead in setting bond yields to such a level that bond yields, by themselves, force other interest rates up that are pegged to bonds, which can even drive up the Fed Funds Rate. This is EXACTLY what I have been saying will happen. As the Fed releases its grip on the bond market, those bonds that everyone thought did “not see inflation coming” will rapidly price in the inflation that bond investors actually do believe is already here and is coming. THE BIG KEY I GAVE YOU: It is only the Fed’s MASSIVE manipulation of the bond market that has suppressed true price discovery, which is now going to get real again VERY QUICKLY. (Without any price discovery in the bond market, of course it looked like “all-wise” bond investors saw no inflation coming. Practically the only bond investor in the pool was the Fed, since it was buying more than 50% of treasuries issued, and we all know the Fed didn’t see any inflation coming because it kept telling us that!)
What the return of price discovery (the re-entrance of the bond vigilantes) means is that the Fed will BE FORCED TO rapidly raise its official base inter-bank lending rate (the Fed Funds Rate) just to maintain the illusion that it is in control. It cannot be seen setting a low Fed Funds rate as a stated target and having that rate float above its target due to market forces, and it will not be able to maintain that rate at zero as it relinquishes its death grip on bonds, so it will be forced to raise its stated target to match what is actually happening between banks.
Such is the work of “bond vigilantes,” forcing the Fedto rapidly reprice all interest rates for inflation, regardless of what the Fed wants. The tail is starting to wag the dog. The Fed’s only route out of that is to go back to QE in order to rest control back from other bond investors, which would shove inflation into a neighboring solar system. It doesn’t want to do that.
Nomura’s Charlie McElligott warns that a good part of this vigilante action might happen in a quick dump this week because …
We see “-100% Short” signals across every G10 Bond and MM Rate in the model.
In other words, the aggregate of bond shorts has grown so high that those shorts, now that bond prices are falling, will force the investors who are on the long side of those trades to rapidly sell, collapsing bond prices even further in favor of those who are shorting bonds. There is an elevator down here, ready to be taken, and someone at the top has a pair of loppers around the cables.
The market has already priced in four rate hikes this year, but that is still below what Fed members are saying is likely. Both Nomura and Deutsche Bank are suddenly saying (just since I wrote that Patron Post that said yield escalation was coming quickly) they anticipate the Fed will lead off with a shock move to signal to everyone it is finally taking inflation seriously, raising its Fed Funds rates by half a percent in one jolt in March; i.e., the second its taper is complete. Beyond that, Deutsche now says,
The most likely scenario is that the Fed begins to raise rates at each meeting this year beginning at the March meeting,
Deutsche isn’t the only one who foresees a shock move with an initial 50-basis-point rate hike:
whether 3 to 4 would therefore be enough. The @federalreserve could work to restore its credibility with an initial 50 bps surprise move to shock and awe the market, which would demonstrate its resolve on inflation. The Fed is losing the inflation battle and is behind where it
— Bill Ackman (@BillAckman) January 15, 2022
Ackman, from what I’ve seen, talks his book — i.e., says whatever it takes to manipulate the listening stock market to do whatever is good for his positions — and it sometimes works! However, BofA has also hinted at a 50-basis-point initial hike in March, and Jamie Dimon of JPMorgan is now predicting 6-7 rate hikes this year.
The last time the Fed moved at this speed was 22 years ago when the Fed popped the dot-com bubble. Interesting, since I have also said this market destruction is likely to play out like the dot-com bust.
Here is what Charlie McElligott says about how quickly the bond vigilantes could make all of that happen (as early as this week) in his always half-digested, gut-bomb quant talk:
The potential for a “short gamma / negative convexity” event grows substantially on Dealer hedging “accelerant” flows, which would push 10Y yields beyond 1.90% (to the inevitable 2.00% Maginot Line)…
Heck, that event is already looking easier than it is to read. He’s saying interest rates may change even faster than they have been due to the short positions in the bond market, and I’m saying that will accelerate the Fed’s already rapidly changing stance (as I described it in that Patron Post) by pressing the Fed to hike its Fed Funds Rate even faster just to keep up with the real-market pricing that the Fed’s step back from bonds is now allowing. These shorts could reek havoc this week, making even March a late date for the first re-rate out the gate. I have always stated this new inflationary economic climate would drive the Fed into hyperdrive because the Fed was completely missing the boat with its mantra last year that inflation was “transitory,” but this would be even faster than I anticipated if those gamma shorts kick in.
The key mover right now is the 10-year yield, which has already slammed well above its 1.8% barrier since the Fed taper got serious this month and appears to be reaching for 2%. While I was writing this article, the 10-year touched 1.899% intraday. That’s as close as you get in Marketworld to tagging 1.9% without actually doing it, and the week’s only half over. So, it may be that the short situation Nomura sees as a possible climax on Friday is already starting to play through. No one wants to wait to the last day in a crowd like this.
When bond yields are up, prices are down, so the kind of bond action we are now seeing leaves bonds cheap relative to stocks, meaning the old reason for buying stocks that drove the stock market through a good part of the past decade — TINA (There Is Nothing Else) — is dead … or, at least, on her death bed and fading quickly.
Suffice it to say, the counterbalance to the price of 10-year treasury bonds is yields, which have made a quick trip up to 1.9% and may even hit 2% very soon, allowing a rapid ride down on the bond price elevator. It is at 2% that you can say the cables simply got cut, and we’ve started an all-out bond crash. Hitting that level so quickly, if it were to happen, could cause all kinds of things to go catastrophic because stocks and other markets react even more to the speed of bond interest changes than the amount.
McElligott is not saying, however, that bonds will go there this week, but he’s saying the way the market is shorted, it currently has the potential to take that kind of dive in bond prices (rocket-ride in bond yields). There would be blood in the streets at that pace to that level.
McElligott refers to this as a
financial conditions tightening tantrum
and, therefore, warns,
US Equities Index Options positioning into Op-Ex this week is particularly dicey.
That is because, if bond yields rise that rapidly, letting bond prices fall, money will flee from stocks to bonds because TINA lies dead under the crashed elevator at that point. McElligott warns to watch the 127 level as the tipping point on the ten-year. Below that, the elevator has lots of room to fall unhindered.
Aside from this week’s possible accelerant, Andrew Ticehurst, a rates strategist at Nomura, say history suggests that 10-year yields are unlikely to peak before the first rate hike of the cycle. Since we’re already essentially tagging 1.9% today, and the first actual rate hike implementation is probably two months away (though the Fed’s decision may come as early as this month), the vigilantes have time to work.
All of this has already resulted in a violent flattening of the yield curve, even though all yields are moving quickly to price in inflation as the Fed leaves yield-curve control behind, as I also said would happen. That indicates we are pressing rapidly toward the recession I promised for the start of this year. David Rosenberg notes this as well:
Inflation is 7% and the last time this happened, we had a double-dip recession. Prior to the pandemic, 5%+ inflation presaged all seven recessions over the past sixty years. Les jeux sont faits. #Economy #Inflation #DavidRosenberg #RosenbergResearch #RRMacro pic.twitter.com/ZXXjCARL9D
— David Rosenberg (@EconguyRosie) January 13, 2022
Rosenberg went on to note that the Fed prepping the market for a 25-basis point hike but then leaping in with a 50-basis-point hike will “do wonders for its communication skills!” From all appearances, as laid out first in my Patron Post but now with additional support here, we appear to be entering the Fed’s most rapid tightening schedule in history!
Hmm, ending QE and hiking interest rates just as we slide into recession, what could wrong with that?
So Jamie Dimon says 4-6 rate hikes .. hilarious,we haven't even had 1 yet and inflation is on fire. Anyone remember the last time the FED forcasted several rate rises a few years ago ? . we got one 0.25…the stock market threw its toys out the pram and it was quickly reversed !!
— Paul Cramer (@PaulCra75770194) January 15, 2022
(And, if you knew what additional big move the Fed has in store as I laid out in that post, you’d know we’re really in trouble. That is how desperate the Fed is to catch up with the inflation it let run out of control, and it cannot so easily back out of its tightening this time if the pram runs off the rails because inflation is the Fed’s pram driver, and it’s not letting up.)
Said recession, coming from the Big Bond Burst that is starting to unfold, will also include a spill over into housing as the probable crash of the bond bubble takes out the everything bubble, which includes the housing bubble by driving up mortgage rates:
The Fed’s now-clear assault on “too-easy” financial conditions via their pivot to “Inflation Hawks” as it has become a non-partisan political issue into mid-term elections … with the knowledge that mortgages have not yet even begun to feel the full sting of the coming market ownership reversal, as the Fed … forces actual “price discovery” … MBS spreads are already moving meaningfully wider… affordability in the housing market evaporates completely.
I’m already seeing real-estate ETFs go wonky and even commodity ETFs seem to be joining the stock market’s slide, so I’ve pulled my money back out of those. They were doing great for awhile because of inflation. Suddenly, not so much. I guess that is what the bursting of the everything bubble looks like. Even what seemed safe group may join the momentum of the slide.
Of course, McElligott’s big warning about the potential short trip down in bond prices may not come into play. In that case, all of the above still plays out, but just not as quickly because I’ve said all along to expect a tug-o-war between stocks and bonds that likely plays out over months as those two markets tussle for equilibrium.
McElligott, however, is not the only one saying this could all slide quickly now.
Real yields may be about to see a massive move higher…. Real yields are racing higher, with the 5-yr TIP rate now at -1.22% the morning of January 18. [Two weeks ago] the 5-yr “real” yield was -1.6%. The higher this rate climbs, the more the [stock] earnings multiple will contract. The biggest problem for the equity markets is that the “real” yield on the 5-yr TIP may be about to go much, much higher. A technical chart shows that the 5-year TIP rate may make a significant breakout, sending that real yield soaring from -1.22% to around -50 bps. That would be an increase of more than 70 bps, creating carnage in the already overvalued equity market.
Even TIPS (Treasury Inflation-Protected Securities) are not keeping up with the real rate of inflation. You can see the TIPS bond market made a sudden leap up at the end there as soon as it cleared all the 2021 little ups and downs. Now pressed up against its next point of resistance, it can make another abrupt run up another 70 basis points if it breaks through resistance, which still won’t have caught up with inflation as they are supposed to.
On the stock side of resistance, the S&P and Dow are already below their 100-day moving average and still falling. As noted the NASDAQ is below its 200-day average, and mid-day today is falling further. For the moment, this is moving money out of stocks and into bonds, easing bond yields a little. That is the seesaw I’ve said we should expect when the reason for stocks falling is bond yields rising due to the Fed tightening faster due to scorching-hot inflation at the Fed’s back, leaving it with little choice. Here is another key point I don’t want you to miss: All of these inflationary pressures leave the Fed unable to back out so easily as it did in 2019 when its 2018 tightening went off the rails.
Hear others saying it, so you don’t have to just take my word for it
Here is some perspective from others on the Fed’s moves and resulting bond action:
Last week’s “Fed hawk shock” warrants trading the new higher rate range “with a bearish duration + curve flattening bias”
Bank of America (via Zero Hedge)
Based on the rate movement in January so far, we think only a small fraction of the anticipated QT effect is priced by the market.
The repricing of duration to start 2022 signals risk of higher yields ahead [as] too many central banks are on the move or sending signals, rendering traditional cross-market valuation metrics less reliable. [An early start to Fed QT] will steepen the yield curve,and open the door to more rate hikes over the cycle — not fewer — raising the terminal rate the Fed could achieve [to 8 hikes].
We see more room for yields to rise, although the path to higher yields is likely in stages
It feels like it was only last week that we published our 2022 Market Outlook. Technically it has only been two weeks, but so much has gone on…. Certainly, in 2022, January is forcing us to do more than we usually do in a quarter, if not a year! Now it is like there is some race to be the first to call for more aggressive Fed actions!
Academy Securities via Zero Hedge
Does the Fed have little choice?
What the Fed actually does will likely depend on how economic data — particularly inflation data and wage data and GDP data — look at its future FOMC meetings. I will go into all the reasons that shortages are going to continue or even worsen so that Fed-fueled inflation is going to keep rising in another post (likely my next), but let’s look at the conundrum the Fed is already in.
Over the past few weeks, Fed speakers are bemoaning inflation and voiced their wishes to squash it. They frequently mention how effective their monetary toolbox is in managing inflation.
There lies a massive contradiction between words and actions within these numerous speeches and media appearances. If the Fed is so intent on fighting inflation, why are they still stimulating the economy and markets with crisis levels of QE? Why is the Fed Funds rate still pinned at zero percent?
That is exactly the question I asked in my last Patron Post. It is perplexing if not absurd. Think about it: If the Fed is ready to go to all the tightening laid out here (and even further and faster as noted in that post), WHY are they still easing? When have we ever seen the Fed talking about quadrupling down on how quickly it will increase its rate of tightening, while still continuing to add more stimulus to the economy in greater QE amounts than at just about any time in history? How bizarre is that? (You can translate this situation as “the Fed is going to SLAM things into reverse.]
That’s right. This is the part I said at the start I’d show below. With all the rapid Fed tapering, the Fed is still running a level of QE that is RAISING its balance sheet faster than anytime during the entire post-Great-Recession period. That means all the problems already seen happening in bonds and consequentially in the stock market are unfolding at a point where the Fed is still easing at historically enormous levels. Hitting the halfway point on the Fed’s taper only means we are down to the former record levels of balance-sheet EXPANSION seen from the start of the Great Recession to end of the Fed’s “Great Recovery.”
What happens when the Fed actually gets to zero expansion by March AND starts adding those interest hikes it is already talking about and starts doing the other massive move I’ve told patrons is coming? Do you seriously think markets that are already flailing this badly are going to survive even the interest hikes or the end of balance sheet expansion? They are not even surviving a 50% cut in the rate of expansion with no interest hikes, though the market is clearly prepping by pricing some of all this in quickly now; but it as, as others noted above, far from fully priced in because the bond vigilantes have just started to wake sleepy investors up by making some noise. (And investors thought inflation wasn’t going to hurt because of what the Fed had been saying and because bond prices were deceptively locked by the Fed’s gross manipulation in the bond market into showing no inflation in sight.)
Within this ambiguity comes an abundance of risk for investors. If the Fed walks the walk and fights inflation vigorously, markets appear ill-prepared for a sharp decline in liquidity and resulting market instability….
The Fed is walking a tightrope between instability and inflation. Can they successfully tame inflation without causing severe market dislocations? The tightrope is thin, and the consequences of falling off to one side or the other are severe. Investors best think about the Fed’s perilous act they are getting ready to attempt.
Here is where the real Fed Funds Rate (i.e., adjusted for inflation) sits right now:
Do you think the bond vigilantes are going to let it rest there? Do you think scorching inflation is going to allow it to rest there now that bonds are freed to price inflation in? Just to set its target base rate at zero, adjusted for inflation, the Fed would have to now set its nominal rate at 7%! That is how you fight inflation. In the seventies, we saw Paul Volcker take it up to almost 20%!
So, if the Fed walks the walk, that is what it took to stomp inflation’s soaring head down back then. The Fed had to raise its base interest rate higher than inflation. But we have a stock market that can’t handle taking away the QE punchbowl even with the Fed’s nominal rate resting on the ground floor at 0%, and half the punchbowl still remains at the table!
Which is why I bet my blog that soaring inflation will force the Fed to tighten faster and faster, killing the stock market. We are now in those times. As we now watch the Fed do all I said it would do because of hot inflation and watch bonds, then, do all I said they would do because of the Fed and watch stocks begin to do what I said they would do because of bonds, the funny part is watching the chart-watchers who ignored inflation (or laughingly didn’t even believe it was happening because of their bond theories that didn’t factor in the Fed’s manipulation) scramble to catch up. They ignored Fed fundamentals (from which all the stock and bond market money originates), so they are now rapidly and repeatedly revising downward their prognostications about where the stock market will find support to rise to new highs as their stocks show sentiment rapidly changing to align with inflationary fundamentals.
I pegged the timing for this rapid change in sentiment not on the calendar, but on the event, which I said would be the Fed’s realization that it had ignored inflation too long due to its grossly misguided disbelief that inflation was transitory and the Fed’s resultant regime change on easing. As a result of its failure to adequately estimate inflation, the Fed now has to resort to market-shocking action to battle inflation back down — all of which isn’t shocking to anyone if you’ve been following my thinking here and in my Patron Posts. We saw that change in the Fed at the end of last year, so the Fed’s rapid moves toward regime change were the cue that everything would soon be tilting badly.
It is quite possible to see where these major fundamental forces would be taking us before they even came into play by plotting a trajectory, as I have, for where inflation was certainly heading, in spite of what the Fed was saying and what bonds were showing in their rigged pricing. That required knowing what was driving inflation on the producer end where it appears first and understanding how inflation would force the Fed to catch up quickly in its response once it realized its error. It required understanding now bonds would bear no reflection of inflation until the Fed got out of the QE bond-buying business, leaving most players blind to inflation’s reality, and how the change in bond action would collide with stock-market sentiment as soon as true price discovery became visible to all in the bond market. You have little time left now to make changes.
Yes, that’s a long chain or reason and deductions, but it is exactly the chain of events I have consistently laid out here, describing why these things would happen in stages with almost inevitability, since the summer of 2020. The Fed has never had a game plan for removing its easing that works, and it never will because you cannot remove the money that is making the market without removing the market you made! Fundamentally, it is really just that simple. I said it going into the Fed’s tightening in 2018, and I said it as we anticipated the Fed’s present tightening, claiming “tapering will be tightening,” and already we see how it is!
With a massive portion of the stock market bubble having been built on margin debt made possible by practically free Fed money flowing into markets and looking for a place to park, ask yourself what that adjustment, as the easy money dries up, will look like compared to similar times:
Do you seriously think the Fed isn’t going to fall off the tightrope it has to walk between screaming inflation and the death screams of the stock market and bond funds that are highly invested in low-yield bonds in the face of bond vigilantes taking yields and all other interest way up?
And this central-bank tightening is happening everywhere at once:
The selloff in Treasuries isn’t staying in the U.S. as traders ramp up bets on further bond declines across the globe. Overnight, benchmark German debt yields turned positive for the first time since early 2019, with the rate on the 10-year bund climbing four basis points to 0.02%. While the ECB is currently behind the normalization path of the Federal Reserve and Bank of England, traders are weighing the prospect of tighter policy.
“Positive yields are here to stay,” declared Antoine Bouvet, a rates strategist at ING Groep. “It’s a brand new world….“
In the meantime, predictions surrounding the number of rate increases the Fed will have to implement this year keep going up.
China has said it will do the opposite, but most of the world’s central banks are going into tightening hyperdrive.
However, can the Fed even control inflation?
The Fed can raise rates that will impede economic growth and dampen demand for products. However, they have zero control over the supply line problems and shortages. While some are alleviating, Omicron results in a fresh round of new shortages and production problems.
The Fed can only control its half of the inflation problem. Remember, inflation happens when too much money chases too few goods, and the Fed can do nothing about the latter part of that equation. And it will really have to scramble to do anything about the first part because it has already dumped tons of money into the economy and, as seen, will still dumping in tons more for the next couple of months! How insane is that?
Next up: Why inflation is not about to give the Fed a break.