This past week was a stormy ride through the badlands of hell for bonds. Government bond prices took their worst cliff-fall since the Marshall Plan. The panic run of bonds over the edge was sparked by the fantasy belief that Russia might be retreating, bringing a rapid end to Putin’s invasion and the opposing sanctions.
The flight of fantasy here was that an easy end to the war might leave the Fed free to focus on nothing but fighting inflation. At least, that’s how one story in the financial news called it. How one can assess the mind of the market toward such a thing as a wartime retreat that hasn’t happened, is beyond me, but I do think a new marshall is riding into town, and he’s got all the bond vigilantes fired up about something.
The bond-age is ending
It wasn’t even a week ago, I wrote the following:
In the bond realm, the interest trajectory shown above is a rocket ride. I’ve also said that the point where rapidly climbing bond interest is likely to cause serious trouble for stocks was in the 2.25%-2.5% range. Well, we’ve clipped almost to the top of that range in the space of one day; so, we’ll see what happens as that fact gets digested by stock investors; so far they seem to be in a state of denial about what they are seeing:
The graph I was pointing to was this one:
Then, in just a couple of days, the 10YR treasury blew right through the 2.5% top of the range I had said would be the exit from low-interest days of easy riding to greater trouble. Bonds hit an intraday high of 2.503% at 11:14 ET on Friday. Since then, they have bounced along just few hundredths of a percent to the underside of the 2.5% level.
Earlier in the week, Wolf Richter noted the likely cause of this week’s muscular moves as,
One of the trigger points was possibly – though you can never really tell with these crazy markets – that Fed Chair Pro Tempore Jerome Powell spoke, confirming the Fed’s new-found religion in using its monetary tools to tamp down on inflation, at least a little bit, while trying to achieve a “soft landing” or at least a “soft-ish landing.”
As Wolf also noted and I’ve been saying here,
All Treasury yields are still ridiculously below the rate of CPI inflation, which spiked to 7.9% in February, and they have a lot of catching-up to do.
In other words, as quickly as the bond vigilantes are riding up interest rates, they still have a lot of catching up to do; so don’t expect them to slow down, other than the occasional breather. As I’ve warned for months, when the Fed’s taper ends, cling to the saddle horn and get ready for the ride of your life. In the world of bond traders, this was such a ride.
Forming a pattern that forecasts recession, the bond yield curve blew out on the front end particularly fast as Zero Hedge noted on Friday:
Things are escalating very rapidly in bond-land as short-dated Treasury yields are literally exploding higher. All of which is leading to dramatic flattening in the curve.
Or as Wolf colorfully described it,
The yield curve groans under the Fed’s gigantic balance sheet.
The weight of the Fed’s gargantuan balance sheet is pushing down on long-term yields that the Fed spent years repressing with trillions of dollars of QE since 2008, and most radically since March 2020. QE has ended, but the weight is still there.
Which means, get ready for all kinds of new fun in mortgage interest (based off the 10YR only because most mortgages get paid off in that time due to resales, but influenced by the 30YR that matches mortgages in term) because the Fed will start lifting that weight with quantitative tightening in another month or so. They have already said they will run their QT roundup at the fastest gallop in history as they try to ride down hard on stampeding inflation. That may release the long end of the curve (10s and 30s) to rise with the rest of the rates that are already on the run because it was this far end of the curve the Fed was focused on suppressing with its QE in order to stimulate the housing market with cheap mortgages. Selling off those bonds will likely over-supply the market, demanding higher yields (lower prices) in order to attract more buyers. As I’ve said before, what goes up (liked those prices did under QE) comes down when you do the opposite of what you did to send it up. It’s kind of a no-brainer.
In the meantime, that run-up in rates looked like this in Friday’s bond action across 2YR maturities and longer durations as purportedly the announcement of a wartime retreat by Putin’s army released the bond vigilantes to ride herd on bonds again:
The laggard in that gain by quite a bit was the thirty-year, leaving it finally very near the others in interest since its resting place sits a little higher than they do, and they ran up faster.
Yield curve pancakes
Looking at that in terms of how much bond yields have changed relative to each other since the start of the week, the difference in their interest increases looks like this, where you can see things have moved up a lot more for the shorter-term rates
This has left the yield curve pancaked at the top as shown below with everything of longer duration than the 1YR having risen so fast relative to the 30YR (the bond least vulnerable to immediate recessions) to where the 20YR is now higher than the 30 (inversion of the curve) and rest barely lie barely below the 30, and the two, four, and six-year bonds are now all in an inverted position to the 10 (the 10-2 inversion being the one usually seen as most indicative of a recession) So, we’ve now got us one full-on-recessionary, weird-and-wild-looking, blown-out yield curve:
As I wrote in my recent Patron Post,
One other insidious aspect of the bond bubble blowing up is that the yield curve for bonds is now rapidly flattening as bond vigilantes seize the reins on the bond market that the Fed is releasing. That flattening presages a recession…. This time it is a delayed indicator because of how tightly the Fed held the reins on bond pricing, restricting its own best indicator like a broken gauge to where the Fed doesn’t even see recession is already at the door.
Having languished for the better part of two years, the bond vigilantes have awakened, and they are now rapidly making up for lost time.
The market’s response
Stocks aren’t showing any trouble yet as they continue to rebound, apparently happy at the delirious notion this war may be winding up soon, but the market did make one change:
the surge in rates is finally starting to impact stocks as yesterday’s return to growth is rapidly being erased.
What had started to look like a return to growth stocks (the kind favored in the NASDAQ) faded, and it is the NASDAQ that had gone full-bear and then recovered a little over the past ten days, but that recovery appears to be putting in a top now, so may turn out to be nothing but a bear-market rally, said rallies usually being rather intense:
With inflation running so hot and bond yields running to catch up, Citigroup just said today it anticipates the Federal Reserve may make a large 50-basis-point hike at each of the next four Fed meetings followed by two 25-basis-point hikes. So, by the end of the year, they expect a 2.5 point increase in the Fed Funds rate on top of the increase the Fed just made.
The market is now pricing in 60% odds of nine 25-basis-point hikes by the end of the year. Those projections have been rising for months and may well keep rising as time marches on, and so do the bond vigilantes.
We are revising our “base case” for Fed policy rates from 200bp of rate hikes in 2022 to 275bp in rate hikes in 2022…. In addition, “we expect the Fed to continue hiking into 2023” and sending the benchmark rate to a range of 3.5% to 3.75%
Moreover we saw during the Fed’s last big QT rodeo that, once the tightening got up to speed, the stock market did not like QT and interest hikes at all! And that part of the ride all is still ahead. This first interest hike was a mere teaser since everyone had been expecting double what the Fed did, but Chair Powell made it clear the Fed will be immediately picking up the pace.
The dustup is global
Globally, the bond market is puking like this (rising yields are reflected here as falling prices):
That is the sharpest plummet in decades — going all the way back to the seventies, though the graph only goes as far back as the turn of the millennium. As you can see average global bond prices are taking out their bottom trend line, which indicates a reversal in the trend, and they’re still falling, so it appears the long bond bull run globally has finally put in its top. That rodeo has ended; the bull has died; the rare bear in bonds is back:
The third great bond bear market is underway, Bank of America strategists have declared…. The previous bond bear markets were from 1899 to 1920, and from 1946 to 1981.
Due to the upward press in yields (downward prices), the number of negative-yielding bonds that had accumulated globally since the Great Recession has suddenly plunged from 18 trillion down to 2 trillion. Not bad work for the bond vigilantes so recently set free by central banks backing out of bond markets. This was the key I gave for understanding what was coming because so few in the marketplace seemed to realize that the end of massive QE mean the end of central-bank control on bond yields that was keeping the yield-curve in proper form, so everything would reprice to what the market should be and would have already been, had there been any true price discover allowed. The reversion to actual market pricing, I said, would be extreme.
As US yields soared, so did Canadian bond yields. The 5YR Canadian, which sets the pace for Canada’s five-year mortgages (Canada’s primary mortgage is amortized over twenty years but must be refinanced every five), soared 21 basis points in one day to hit its highest level since 2011. One of my warnings in my Patron Post about the housing-bubble bust was to expect trouble in the Canadian housing market.
Following a 50-basis-point hike in Canada’s foundational interest rate, the deputy governor of the Bank of Canada, Sharon Kozicki, sounded like J. Powell after the Fed’s recent rate hike, saying the central bank was “prepared to act forcefully” to bring high inflation back under control. Fed Chair Jerome Powell said earlier in the week America’s central bank needed to move “expeditiously” to battle inflation. So, the fight is on! Expect some rough riding.
As a result of these historically massive gyrations in global bond markets, something weird is happening again in the US repo market. Remember back in the Repocrisis of 2019, which I was calling the Repocalypse, the Fed was freed back to full-on quantitative easing in a hurry as I said would be the only way to kill the Repocalypse beast? The repo monster was born out of the collapse in bank reserves that became too tight due to the Fed’s tightening, resulting in major banks (particularly JPMorgan) no longer being willing to play mumbly-peg with certain gargantuan hedge-fund clearing houses.
Well, repos, which are the interbank lending that lubricates the financial world, are starting to show some bizarre activity again, perhaps due to the $1.2 Trillion in reverse repos the Fed engineered last year to take money out of bank reserves even as it was adding money in, which I saw as possibly being a plan to set aside some ballast it could release back into reserves as it tightens reserves to soften the fall. This it could do by not rolling over those reverse repos. (Reverse repos when done by the Fed take cash out of bank reserves and replace the cash temporarily with bonds the Fed has been holding.)
I can’t say I was certain of that, but it was a peculiar thing for the Fed to be doing over a trillion in cash removal from bank reserves at the same time it was doing trillions in QE to add to bank reserves. Made one wonder why they were hosing up so many bonds in order to add money in the front door of the Federal Reserve System just to be smuggling so much out the back door. Kind of looked like a money-laundering operation.
If the Fed was banking away some ballast it could throw back off as it tightened, it kind of looks like the repo market is getting itchy to get that cash back into reserves before the Fed even starts tightening reserves because tapering the QE has apparently been about all it can take. We see some shaky action going on:
Although liquidity in the US Treasury market is an ongoing issue, traders and investors said there were particular concerns during this selloff.
“People who buy longer-dated Treasuries, like repo, central banks, and insurance companies, tend to stay away when you have that kind of volatility,” Ed Al- Hussainy, senior rates and currency analyst at Columbia Threadneedle, adding that liquidity “isn’t good” and trading large blocks of Treasuries “has become very difficult….”
The Treasury securities market is usually one of the most liquid in the world, and the global financial system uses instruments as a benchmark for asset classes. But it has experienced liquidity problems, such as in late February and early March 2020, when pandemic fears caused market disruptions and liquidity quickly deteriorated to crisis 2008 levels, prompting the Fed to buy $1.6 trillion of Treasuries to increase stability.
Reuters (via Good Word News)
The latter point makes me wonder if the itchy trigger fingers are due banks and others who play in the repo market already feeling the Fed needs to get back to buying trillions in treasuries like it did to resolve a similar itch that lasted from late 2019 into 2020 when it finally went back to full-on QE and ended the itch with a whole lot of salve. And the Fed hasn’t even begun quantitative tightening yet. If that’s what this is about, then yikes when it does.
Investors say liquidity problems this year have not reached the point of threatening market functioning, but concerns have grown over several factors. The first is that the Fed has stopped buying US Treasuries….
Uh huh. Thought so … before I even read that far. That didn’t take long.
Some investors are also concerned that sharp price swings in commodity markets due to the Ukraine crisis and sanctions against Russia, a commodity exporting giant, could create pockets of illiquidity in the financial system. .
Whoa! Wouldn’t one normally wonder how you can have a liquidity crisis brewing with about $10 trillion of excessive Fed liquidity pumped into the market since the Covidcrisis bailout and stimulus programs were added to what remained in Fed funds from the QE recovery program engineered by the Fed to save us from the Great Recession? I mean look at where we are here on the Fed balance sheet:
All of that is still not a enough liquidity in the system just because the curve has rounded off to flat at the very end without even a bit of actual balance-sheet reduction yet??? Oh, and incidentally, look at how far the Fed made it with taking down its balance sheet in 2018 and 2019 before it had to revert to expansion during the last repocrisis, which is that sudden little hump back up in late 2019. You may recall my saying back then that the Repocalypse would only be tamed when the Fed went back too full-on QE , which is that nearly straight-up rocket ride to the moon in 2020 that finally ended the Repocalypse with so much QE that it made the Great Recession recovery period from 2010-2014 look like the starter plan. Any questions?
There’s a new marshall plan in town
Well, maybe the shaking and quivering is has to do with the arrival of new sanctions or maybe it has to do with the fact that Fed QE just ended when it tapered out a couple of weeks ago — the final point in that short tapering of the rate of rise at the top — especially since Fedheads everywhere started talking of going immediately into accelerated QT during those same weeks in which sanctions were nailed in place. Who can tell, since both happened at the same time?
The weakness in bonds this week came after Fed Chairman Jerome Powell said on Monday that the U.S. central bank needed to act quickly to counter too-high inflation and could use interest rate hikes more important than usual if necessary.
The article mentions both sanctions and Fed tightening as causes for the liquidity problems that seem to be percolating up in the repo market. At any rate, something is looking seriously wonky with repos … again … and we haven’t even begun the quantitative tightening that caused all the ruckus last time around. We’ve barely even ended the quantitative easing that markets got drunk on.
Sounds like its time for the Fed to immediately start throwing off that ballast it laid in, if that was the purpose of its reverse repos, but that will leave the Fed with a lot less to throw off as counterbalance to its tightening when that begins a couple of months from now.
Are you seeing a rough ride ahead?
Bid-ask spreads — a commonly used indicator of liquidity — widened significantly in March on short-term Treasuries, according to data from Refinitiv…. Steven Schweitzer, senior fixed-income portfolio manager at Swarthmore Group, said he saw a “pretty big disconnect” on the short end of the US Treasury curve earlier this month – a reminder of the lack of liquidity observed following the global financial crisis.
Uh huh. Those weren’t particularly good times, and we haven’t even started down the Fed’s trail of tightening yet. No problem. Just a few rocks, holes and rattlesnakes in the trail as we all gallop in a pack down the narrow, war-torn, cliff-edged mountainside on the tightening trail. This should go well.
“Bonds and credit are the lubricant of the economy, and when the short term dries up, that’s a really big red flag for us,” he said.
Oh, great, and now they’re waving a red flag to warn us the bridge over Copperhead Creek is washed out. Looks to me like the kind of trap (for this article we’ll call it an ambush in a patch of rattlesnakes) I wrote about last year where I said inflation would rise so hot it would force the Fed to taper faster than ever and then would still be a burning flame at the Fed’s back so the Fed couldn’t back off from its tightening plan, even as the actual end of QE crashed markets. So, here we are on the rattlesnake trail, and we’re closed off ahead and behind.
Our fearless leader, Marshal Jerome Powell, rousted us all out of the marketplace saloon from our drinking fun a few weeks ago when he shot out the bottom of the QE keg to end the revelry and announced he’d be setting the place afire soon with QT. The markets were already reeling like a drunken saloon table dancer, ready to swoon, when the beer was merely running low. So, who’s going to catch this haggard barmaid when she falls off the table in the barroom brawl toward the door that is set to begin when the place lights up?
In closing this article, I dug up an article from last summer that I think provides a bit of torn trail map to what is happening now as the reverse of what was brewing then:
Under the reassurance of the Federal Reserve, the financial market spree continues. It seems that everything is still flattering, but in an unconcerned corner of Wall Street, a storm is brewing.
Turns out, as I read on to discover what the trouble I’m sensing might be all about, I come across the same gun-slinging marshall who forewarned of the last repo crisis, from whom I had taken the travel tips that got me to my own prediction of the 2019 Repocalypse:
Zoltan Pozsar sensed the crisis. The 42-year-old Credit Suisse analyst born in Hungary is known for accurately predicting the trend of the reverse repo market. A few weeks before the great turmoil in the U.S. currency market in 2019, Pozsar issued a warning, which earned him the nicknames “the oracle of market plumbing” and the “repo legend.”
His warning two weeks before the Repocalypse broke out might be why he earned his monicker in the Wild West Wax Museum of Fame, but I had listened to the great guru’s hints of trouble down the road half a year before that and laid out my prediction of problems to come based on the rumblings I was hearing and a little simple logic about what Fed tightening would do in my own little mind.
Well, the Marshal Pozsar was sniffing around again last summer and apparently hot on the trail of a brewing problem:
This time, Pozsar predicts that a large amount of money in the US currency market will change hands this summer, reaching trillions of dollars. “If you treat bank reserves as a second card, then this deck will be reshuffled.” In Pozsar’s view such a large-scale capital rotation is likely to trigger market turbulence that is underestimated by most people.
Intriguingly, it was shortly after all that money-sloshing liquidity that the Fed began its big and mysterious reverse repo operations to soak up the overspill from all the money it was pouring in. Now we seem to have the reverse of the reverse repo problem brewing. How much longer until old Marshall Powell can’t shoot the rattlesnakes fast enough as we’re galloping down the trail behind him with inflation burning up the path of retreat behind us?
It doesn’t seem to me most of the market is paying any attention to the shakedown in the repo market right now, but once again, something is not right. Another storm is brewing.
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