The Dow, the most easily and commonly manipulated index, has gone nowhere since failing to hold its 3.618 Fib extension at 34,430. It begs the question: what’s the holdup?
Usually, when a closely followed index goes sideways for a while, it’s because an important moving average is moving into position for a backtest. But, is that the case here?
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I had an great question yesterday regarding the bond market: “Is it possible the fear of pandemic in spring 2020 affected the behavior of 2yr and 10 yr and then indirectly triggered the crash?”
Pebblewriter longhaulers will recall that our bond cycle model forecast a severe plunge in interest rates long before anyone was talking about a pandemic. In August 2019, for example, we were already anticipating a drop to near or below zero around December 2020.
It’s what the charts suggested, as we posted in April 2018 [see: Bonds – a Buying Opportunity]…
…and it’s what was necessary in order to keep America’s books balanced. Annual debt growth was averaging 5%, and debt:GDP had topped 100% for the past five years.
As we pointed out in July 2019 [see: Why Interest Rates Must Not Rise] the only way to keep debt service from overwhelming other federal expenses had been to crash interest rates.
The trick was how to force interest rates lower without alarming us economist types. Past maneuvers had involved adjusting Fed policy (not terribly effective for medium and long-term rates) and forcing inflation lower by forcing oil and gas prices lower as occurred in 2014-2016 and late 2018 (detrimental to stock prices.)
CPI, which had spent most of 2018 above 2%, had declined to a more manageable 1.7% by September 2019. But, the year-end ramp job in oil prices sent CPI up to a troubling 2.3% by December. The 10Y rose from 1.43% in September to 1.95% in December and, as the chart below shows, threatened to break out. Something, as they say, had to give.
As the big brains at the Eccles Building were spitballing potential solutions, the most extreme case of deus ex machina imaginable landed in their laps. COVID-19 did the Fed a solid – albeit one which went way overboard.
Oil prices, inflation and the 10Y were suddenly in a race to zero (oil won) and the Fed suddenly faced a slightly bigger problem: how to prevent Armageddon. They needed higher oil prices, interest rates and inflation just to talk equity investors (well, algos) off of window ledges.
It worked so spectacularly well that they painted themselves back into a corner very similar to the December 2019 one: rapidly rising inflation and interest rates thanks largely to spiking oil and gas prices – exactly what our models predicted would happen. YoY gas price increases and CPI have been so highly correlated that they are now literally on top of one another.
For the past few thousand years, this would have been a serious problem. Everybody knows interest rates spike when inflation spikes. Since the Fed essentially took over the bond market, however, they’ve been able to convince bond investors (well, algos) that spiking inflation isn’t a problem and, even if it is, it’s transitory.
Want proof? Rates have actually declined since April’s 4.2% CPI print and are nearly back to the same level as before the bomb was dropped.
If I walked up to you on a cloudless day and insisted that shaking my rain stick will make it pour, you’d probably double over with laughter. If I had a secret accomplice spray water from a garden hose all over us from an undisclosed location, you might begin to wonder if I was right.
That’s what’s happening with interest rates right now. Except the rain stick is the Fed’s prognostications and the garden hose is actually a low-flying supertanker carrying 20,000 gallons.
Of course bond investors care about spiking inflation. But, with the Fed pumping billions of dollars into the bond market every day (more on days with alarming economic data) to force interest rates lower, they can claim that said inflation (“did we mention it’s transitory?”) is obviously not a problem. And the dopes in the financial press eat it up because, by God, they’re soaking wet.
Instead of rising, interest rates decline, proving to all (especially the algos) that the Fed must know what they’re talking about or — to us more cynical types — that they’ve completely destroyed the bond market’s price discovery mechanism.
So, did fear of the pandemic affect bond behavior and, thus, cause the crash? Absolutely – though it’s a bit of a chicken and egg situation. Everything unraveled at about the same time in the mother of all negative feedback loops.
The irony is that it accomplished what the Fed needed to happen in the bond market — though to excess. The Fed can now use the pandemic as their excuse for the most rapid expansion of monetary supply in history– even as spiraling inflation crushes the disadvantaged whom the Fed claims it’s desperate to help.
Now, on to the markets. No surprise, but futures managed to ramp higher again overnight – creating the illusion, at least, that the downside case is off the table. 
It’s not.
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Interesting piece in Reuters today on Japan’s vaccination efforts and the overwhelming level of infections in Osaka, Japan’s second largest city, only two months ahead of the Olympics.
While many countries are making good progress with vaccinations, Japan – the 11th most populous country in the world – is lagging badly. It’s not the only country in Asia to be struggling.
A close-up of vaccination rates shows that many Asian countries are in the same boat.
Will the Olympics be the next global superspreader event or, perhaps, the next Tom-Hanks-has-COVID! moment?
Those who have put off getting vaccinated might want to consider the number of daily flights from Osaka to the US…
Meanwhile, futures are paying more attention to the daily pre-opening VIX plunge and a bond market which seemingly no longer cares about inflation.
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Yesterday, futures broke out of a very well-formed falling channel for the second time this week. Will it stick this time or is this just typical OPEX nonsense?
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Live by the algo, die by the algo…so the saying goes. ES continues to make good progress toward our downside targets, with the usual assistance from currencies and commodities AWOL so far.
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It comes as no surprise that PPI confirmed yesterday’s hot CPI print, coming in at a whopping 6.2%.
We’ve been beating the inflation drum for so long, it feels a bit anticlimactic to acknowledge that it’s finally here and even slightly greater than we anticipated.
As regular readers well know, I expected central bankers to preemptively head off the problem of higher inflation and higher interest rates by crashing oil/gas prices as they have many times before.
I was surprised to see them pass on this approach and roll the dice with inflation. But, it made more sense once it became apparent that they had essentially taken control of the bond market – the one market that had always “told the truth” about economic conditions. No more.
As strong as yesterday’s equity selloff was, the 10Y barely budged, rising from a high on Tuesday of 1.63% to a high on Wednesday (after CPI was announced) of 1.69%. Today, yields are actually dropping. An orderly channel like the one below is all you need to confirm that yields are being carefully managed.
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Speaking of carefully managing things…I can only imagine the panic around the Fed, the Treasury and the White House when the Colonial Pipeline fiasco popped up the other day. Higher oil/gas prices had helped get stocks to their recent highs, but it was time for the market’s caretakers to take their feet off the gas lest inflation be even more alarming.
A shutdown of the nation’s largest fuel pipeline certainly wasn’t part of the plan – though I wouldn’t be surprised if the hackers had placed some well-timed bets on oil/gas prices in advance. With markets going crazy over inflation, something had to give.
I had the following conversation on this very topic with a very good friend who happens to be both brilliant and an excellent trader. But, he’s nowhere near as cynical as I am. We chatted just after the close.
Less than ten minutes later…
RBOB futures are off nearly 6% from Friday’s highs.
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With futures having already dipped below the SMA50 to tag a key target earlier this morning, the bounce should continue given the algo action focused on VIX.
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April CPI came in at 4.2%, a rate not seen since August 2008.
CPI has topped 4.2% only twelve months in the past 30 years, with the bulk of those instances during Jan-Sep 2008 when CPI pushed above 10Y yields.
The Fed has managed (so far) to keep a lid on yields, providing additional evidence that the bond market remains broken and is no longer a valid source of price discovery.
The details indicate the actual number should be higher, even by the BLS’ deceptive standards. Gasoline, for instance, is listed as having experienced a 49.6% YoY increase…
…though the actual increase was 62%. Rent has risen 10%, well above the shelter increase of 2.1% cited by the BLS.
The rise in both CPI and gas prices continued the high positive correlation seen over the past several years.
The effect on equities has also been muted so far. As with bonds, it has nothing to do with markets “shrugging off” data.
The bond market’s supposed reaction to the most significant economic data of the past 15 months.
Cue the Fed doves, who will continue to insist that rapidly rising prices are a good thing. Wouldn’t it be nice if, just once, the MSM would ask them to explain how spiking food, gas, rent and used car prices will benefit the average American – you know, the ones they claim to care so much about?
By now, it should be obvious that the billlions being thrown at markets is intended to prop up stocks and keep interest rates from breaking out. Remember…when the 10Y broke above and then failed to hold the red TL in Sep 2018, SPX promptly began a 20% correction.
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Blockbuster jobs data? Not so much. At 266K versus over 1MM consensus, it was the worst miss since 1998.
The futures initially held the overnight ramp, taking their cues from VIX, which barely budged on the hugely disappointing print.
But, VIX also hasn’t (yet) broken down the way it normally would if a full-court press were on to preserve the rally – the kind we saw yesterday when Atlanta Fed President Bostic served up new all-time highs on Dow by insisting that tapering mustn’t even be discussed (lest Death Eaters be summoned!?)
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Futures are flat after tumbling to and holding our backtest target yesterday morning. But, pay no attention to stocks just yet. They should continue to be under pressure, with the real action in oil and gas.
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Two quotes by Janet Yellen, only hours apart. The first clearly emphasizes the very real risk of rapidly rising inflation…
“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy.”
…while the other clearly walks back the earlier assertion.
“I don’t think there’s going to be an inflationary problem. But if there is, the Fed will be counted on to address them.”
The reason for the second comment, of course, was the market’s reaction to the first – a tantrum, if you will.
Most of us remember when, in 2013, Bernanke spooked the markets with talk of a rollback in bond purchases. Yellen did the same thing a few years later as Fed chair. This one is slightly different, as it highlights the facts which, by now, should be clear to everyone: inflation is a very real danger to the economy and the markets.
Yellen’s retraction won’t change that.
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