A Little Panic in Short term Bonds

There has been a global rout in the short end of the yield curve.  Australia, Canada, Korea, Brazil, US, etc.  I imagine a lot of it is leveraged curve steepeners that are getting liquidated, as that was the favored trade for the 1st half of this year, and some people are really slow to cut losses or are just too late in closing out long term positions that were the favored trade a few months ago.  This is happening the week before the FOMC meeting, where Powell will tell us about the taper.  

Market participants often remember what happened the last time, especially when it was a big move.  And they usually want to avoid that situation, so I am sure a lot of discretionary managers are very underallocated in bonds at the moment.  After the last FOMC meeting, bonds were absolutely crushed for the next few days.  Bond investors don't want to make the same mistake again.  With yields much higher than back in September (especially the short end), and with a lot of panic liquidation already behind us, its actually probably a good time to look for a long on any dips ahead of next Wednesday for a swing trade.  

The RBA is a perfect example of the lagged reaction function of the central banker, and going overboard reacting to the Rona.  They have been looking in the rear view mirror almost all year long and stuck with their hamfisted yield curve control policy which is like a man in his 20s seeing a man in his 90s walking with a cane and following the old man (Japan) by using the same exact cane.  When the Australians finally got the nerve to test the RBA by pushing 3 year yields higher, the RBA did nothing, and folded like a cheap lawn chair.  Even with their stubborness, they probably realized that the market was right and that they were wrong to stay so easy for so long.   Although they would never admit it.  

The market worry is that inflation will cause the central banks to overreact, pushing up short term interest rates and pushing down long term rates as growth slows, which is being forecast by leading indicators.  While I agree that inflation will be a problem for a while, I disagree that the central banks will aggressively tighten in reaction to that.  If we've learned anything since 2008, it is that central banks, especially the Fed will find any excuse or small sign of economic growth slowdown to delay tightening.  In a stagflationary environment, its much more likely that the Fed would ease than tighten.  People forget that inflation was quite high from 2006 to 2008, yet the Fed aggressively tightened from fall of 2007 to the spring of 2008.  This was before the stock market crashed in fall of 2008.  While oil was surging higher, the Fed was reacting to a weakening stock market and slowing growth and cutting aggressively.  

In fact, this aggressive pricing of rate hikes for 2022 and 2023 sets up the Eurodollars market for a big rally if the economy weakens, like leading indicators are showing, and/or the SPX has a big correction, which looks likely as both monetary and fiscal policy will be substantially tighter in 2022.  I am watching for now, but at these price levels, the short end of the yield curve is looking like an attractive place to park money and collect positive carry, which is getting fatter and fatter as more and more rate hikes get priced in. 

Recently seeing a surge of speculation in TSLA and cryptos, a sign that speculative fervor is alive and well.  Put/call ratios have dropped a lot this week.  Its not a good sign for 2022, or even December of this year, but its not something that I'm worried about at the moment.  There seems to be some hedging trades in index futures and options ahead of the FOMC meeting next week, and VIX has caught a bid.  With the steep contango at the front end of the VIX curve, there still seems to be some demand there for put protection as the effects of the long Sep/Oct pullback have not totally faded away.  

I would start worrying if we continued to maintain very low put/call ratios while the VIX futures curve flattened out, a sign of low demand for puts.  When the 1 month out VIX futures are trading 16-17, then I would be concerned about too much complacency, but right now its around 20, the mid point value between the Nov 17 and Dec 22 VIX futures contract.  

The steep rally off the October lows is starting to slow down, as we are in new high territory.  A parabolic blast higher is the exception, not the rule when the SPX hits a new high.  In most cases, the SPX just grinds up when its at an all time high, which it hit earlier this week.  And with the poor earnings reports from AMZN and AAPL, there is a perfect excuse to sell them down today, and consolidate the gains.  If we get towards 4540-4550, the area of the Sept highs, I may buy on that dip.