Apex of Fear in Bonds

There is palpable fear that the Fed will be hiking rates much more quickly than the consensus analyst expectation of 2 times this year.  First it was Dudley, followed by Yellen talking up a rate hike for March.  Then came the blowout ADP number on Wednesday.  Then Draghi was unusually sanguine and positive on the economic trend in Europe.  And the NFP today was strong, as many expected.  This is a perfect storm for bonds.  Now we know what that fear level corresponds to in terms of price.  2.60% 10 year yields.  That is the level that yields topped out at in December.  The paper napkin chartist in me sees a double top in yields at 2.60%.

I see very few bullish bonds here.  Most are beared up beyond belief, whether due to the chart, or to Trump's expected tax policies, or because they think GDP growth will get to 3-4%.  I believe those views are way too optimistic.

It is normal for the market to selloff into a feared event.  That is what happened with bond selling ahead of an expected strong nonfarm payrolls report.  We got that report, and yields are actually going down a bit, even though it beat consensus expectations of 200K jobs.  If they already sold ahead of the event, well, there is only two options left, if they don't short.  And most bond managers don't short.  So that is buy, or do nothing.  Sometimes trading is just a logic game, and it is not complex logic.  But it does require taking risk when others don't want to.  Some people consider that dangerous, but it's not so dangerous if the discount in price amply pays for the "risk" taken.

The risk that traders are pricing in is for a more aggressive hike cycle by the Fed.  Both for bonds and stocks.  But unless Yellen has suddenly changed her stripes, she will stop in her tracks if the equity market gets shaky.  And based on how the market is trading over the past week, and the large inflows into equity ETFs and mutual funds, we are topping out.  The Fed is considering aggressive hiking into a highly indebted global economy, into an overvalued topping S&P 500.  That is a recipe for disaster.

It is just fund managers, and now retail, chasing short term performance, with disregard for the long term.  The biggest source of alpha for a fundamental trader is to buy and sell on a long term time frame.  That is the time frame that is least crowded.  You cannot consistenly trade a short time frame or you will get eaten up by the HFTs.  For those looking on a long term time frame, the opportunity is in shorting this overvalued stock market, or going long bonds.  Both should work out on a 1 to 2 year time frame.