A Different Bond Bear Market

This is not your 2013 bond bear market.  Or the 2006 bear market.  You have to go back to late 1999/early 2000 bear market to get anywhere close to this kind of protracted selloff in bonds.  Ironically, the turtle like pace at which the Fed has chosen for this rate hike cycle has only lengthened the bearish phase.  And according to Eurodollar futures, the Fed is priced to hike at least 3 more times before they finish. 

I have been skeptical about the Fed raising rates as much as the STIRs market has priced in, but they have gone beyond market expectations, and Powell is clearly not into dovish moves like Bernanke and Yellen.  The US economy is holding on with steady growth, although the leading indicators point to a softer economy in 2019.  In 2000, the 10 year yield topped out in January, 4 months before the last rate hike in May.  In 2006, the 10 year yield made an initial top right around the last rate hike in June 2006, and then retested that top a year later in June 2007.  The only reason that bond bear market was stretched out into June 2007 was because the stock market kept grinding higher with commodities prices and made bond investors nervous about potentially more hikes down the line.  The economy had already peaked out several months before June 2007. 

So what will end this bond bear market? 

1.  SPX has to go down.  The first and most important component is the stock market.  There are two economies now in the US.  The top 10% economy, and then the 90% economy.  The top 10% own a lot of US stocks and other assets, so their economy is sensitive to the stock market.  The other 90% is stuck in a deep malaise that is stagnant and mostly insensitive to the stock market.  In fact, they would be better off with a weaker stock market and lower housing prices and lower inflation, because their wages aren't keeping up with increasing prices for services. 

2.  Be within 2 meetings of the end of a Fed hiking cycle.  Since the Fed seems to be on a quarterly hiking schedule, the market has to sense that the next rate hike is the last one.  That will bring in the sidelined money that feared the uncertainty of future rate hikes.  Right now, it seems like Powell wants to raise at least once more, in December, for sure, and probably 2 more times next year as long as the stock market doesn't meltdown.  So this is somewhat related to what the SPX does next year.

3.  Chinese economy getting worse.  Europe and Japan have been zombiefied so they are living corpses that occasionally show a pulse but rarely move the needle.  A Chinese debt or currency crisis would be a game changer for the world economy.  Even without a crisis, if China enters into the 1990s Japan phase of their economic cycle, low growth will be a drag on the global economy and increase demand for bonds. 

We still don't have the SPX showing clear weakness, although initial signs of topping can be seen in market internals, as new 52 week lows expand at both the Nasdaq and NYSE.  Powell still seems hell bent on hiking till something breaks.  The highest probably situation is China getting worse, which then spills over to SPX weakness, leading to Powell stopping rate hikes.  That could be a 2019 story.  The rest of this year should be relatively calm as China is pumping in a ton of liquidity, cramming money down state owned enterprises' throats, which should at least keep Humpty Dumpty together for a few more months. 

As for the current market, we are in the middle of a pullback that should be more vicious than the one we saw in early September.  The complacency is higher now and the market internals are worse.  SPX 2870 support has held on the first test today, but it doesn't look like it will stop there.  Thinking SPX 2800-2810 is definitely possible within the next 2 weeks.