Rates are Rising as the Bond Market Begins to Turn Downward
Rates are rising and the much-discussed bull market in bonds, which we’ve addressed at length, is starting its gradual slide down. Like a ball hit deep into center field, the trajectory of the US bond market, having arced up, is now returning to earth. In short: bond prices are falling and yields (and hence rates) are rising.
We have discussed the key importance and metric of the 10Y UST, noting that once its yield creeps past 2.6% (which it has recently done), the bond bubble would begin its first leak as the Fed goes from QE to QT and the US Treasury adds more supply/debt ($2T+) to the credit markets… Well, there ya have it…
The US bond market is not alone in its chronic distortion (thanks to years of central bank rather than natural investor demand for its bonds), but ours is the first major sovereign bond market to see yields/rates rise in a noticeable manner.
This signal matters. Watch the 10 Year UST…
Rates Rising, but US Dollar Falling and Stocks are Rising. Huh?
But here’s something we’ve been wondering about: If yields and rates are rising in the US, that normally means the US Dollar should be rising and US stocks (who relied on low rates to buy back shares and pay dividends) should be falling.
As of now, however, the opposite is happening, despite today’s sudden drop in equities.
Because years of central bank distortion of market dynamics has turned everything upside down…
As for the stock market, many are arguing that stocks are climbing despite the rise in rates simply because the great Trump Tax Cut is too strong a tailwind to let a hick-up like rising rates stop its momentum.
After all, if companies have less money to spend on taxes, there’s arguably more money to build their earnings and hence stock valuations, right?
We, however, don’t think tax savings (priced in months ago) are what’s driving the stock market’s continued bull run.
Instead, we think the rise in these crazy markets is due in part to the fictional meme that global growth is “simultaneous” and earnings expectations are/remain strong. As written elsewhere, however, neither of these reported “facts” are true…
The “simultaneous global growth” so lauded by the pundits is debt-driven (rather than productivity-driven) and the earnings here in the US are both bogusly reported as well as flat (the S&P average earnings went from 106 to 107 in 2 years—hardly an earnings surge…)
We do acknowledge, however, that rising rates do traditionally signify stronger economies, and thus stocks can and have gone up as rates went up. But today, rates are going up in a weak rather than strong economy.
Unfortunately, rates are rising today simply because the Fed can’t buy bonds forever and the US Treasury is dumping more bonds (and hence debt) into the supply chain to make up for our continued (and suicidal) policy of deficit spending gone wild.
Again, rates are rising in a weak, debt-soaked economy—and that’s not a good thing.
So why are stocks still going up?
Other arguments for a rising stock market in a rising rate environment include an inflation-based belief that as inflation eventually comes home to roost, stocks will fare better than bonds, and hence money will flow out of bond markets and into a rising stock market. We touched upon this “flow” from bonds to stocks in a previous blog and it’s worth considering.
The Real Reason Stocks Are Rising
Frankly, we think markets are rising simply because nothing fundamental or rational dictates anything anymore. When euphoria replaces risk management, as we saw in the 1920’s, the late 1990’s and during the 04-07 rise into the sub-prime crisis, crazy replaces careful. Today is really no different. Only the bubble is bigger and the hangover to come will be worse.
Why Is the US Dollar Not Rising Along with Rates?
As we move from stocks to the US Dollar, a similar curiosity, as well as evidence of distortion, emerges.
In short: why is the US Dollar falling persistently since mid-December rather than climbing as rates trend higher? As short and long- term rate differentials point to higher yields, this should point directly to a stronger USD as more money flows into our currency.
Yet that’s not happening.
There are a couple possible reasons:
1) Because Trump is pushing for more trade protectionism (from NAFTA revisits to “China-pinching”) which favors “America First,” this suggests less money coming into the US, and thus less wind beneath the wings of the USD; and/or…
2) the US will purposefully depreciate the value of its currency to make the repayment of its massive national debt less burdensome. We are, after all, way over our skis in a debt.
This debt issue is hard to ignore, even if the cheerleading media likes to bury its (and our) head in the sand about our national accounting… The simple truth is that sophisticated bond investors recognize that the US debt is expanding rather contracting, which means the USD is not looking very attractive.
The Fed gets this as well—and frankly, they don’t mind a weak USD—again, because it makes paying down our debt less stressful and keeps yields from rising out of control, in theory at least…
Stated otherwise, the US (having lied about target inflation for years) will “mysteriously” let inflation rise to manage its unsustainable deficit. This means foreigners won’t love the USD either, which could further hasten its slide.
Net result: the same agencies and fiscal leaders at our Federal Reserve who gave us the biggest bubble in market history, as well as the biggest debt burden, are aiming to solve the problem not by addressing growth, but by hitting us with inflation and a flat GDP.
That’s called stagflation—not a recovery.
Of course, a weak US Dollar means gold will eventually have its golden moment.