Monday, January 29, 2018

Stocks and Bonds Gapping Down

Is 2.70% 10 year finally a pain threshold that stocks can't ignore anymore?  The bonds keep selling off, and at some point, that is going to affect the pricing of future cash flows, as well as the negative effects it has on the broader economy.  The Fed is taking its merry old time tightening, so the market is getting ahead of their actions.  The Fed fund futures are now pricing in 2.6 rate hikes for 2018.  That is up from 2 rate hikes at the beginning of the year.  Now it is viewed as almost a certainty that there will be 3 rate hikes now for 2018, which tells you how much the market is believing the Fed.  You haven't seen this kind of forward market pricing of rate hikes for the next year since 2006.  Even in 2017, the market was always vastly underpricing the expectation of rate hikes from the Fed forecast, because the Fed has always overpromised and underdelivered on rate hikes since the financial crisis.  The market is finally believing in the Fed forecasts, which is a game changer. 

Since the Fed will rarely surprise the market by hiking more than its forward guidance, it means there is limited downside for the short end of the yield curve.  Going from 2.6 rate hikes to 3 rate hikes being priced is not going to present much downside for 2 year and under Treasury maturities.  And the long end is supported by end users like insurance companies and pensions which are having to buy more long bonds to match durations of their liabilities, which are increasing as the baby boomers enter retirement.  So the only vulnerable part of the curve is probably the 5-10 year maturities, which also happens to be the point where the Treasury is trying to issue more coupon bonds to pay for the higher deficits this year. 

I expect Powell to be just like Yellen, so he probably won't surprise on the hawkish side, but with the S&P so strong, I also think he will try to do rate hikes for March and June, and then probably wait to see higher inflation or an S&P that keeps going higher before doing anymore. 

Short term, there is the State of the Union speech, and with the market loving Trump, it will probably keep the market bid until Tuesday's close.  The Fed meeting is Wednesday, but it is almost meaningless like most non press conference meetings, plus it is Yellen's last meeting, so market won't put much weight to the wording of the press release.  I expect a sell the news reaction after the State of the Union, so Wednesday should see some weakness.  The weakness in bonds should also be a burden for this market at these Treasury yield levels.  But we'll see, shorting this market feels like betting against Mike Tyson when he was on a roll in the mid 80s. 


Anonymous said...

Cover and go long homie. Take the loss, you will make it on the way back up.

Market Owl said...

Staying with the short for now. May cover around 2805-2810 support.