The Bond Market Is Having A Historic Panic Attack

quoth the raven's Photo
by quoth the raven
Thursday, Feb 16, 2023 - 13:33

Submitted by QTR's Fringe Finance

Never before has it been more evident why the bond market is considered the “smart money” and equity market is considered the “dumb money”.

One only needs to look at recent examples, like Bed Bath & Beyond, whose bonds traded for pennies on the dollar while its equity soared and retail tried to generate a short squeeze (despite the fact that the company was heading directly toward bankruptcy) for proof.

In fact, there have been innumerable other examples similar to Bed Bath & Beyond in other meme stocks over the last couple years, but the general point is that bond markets almost always lead the equity markets in assessing risk, helped along by the fact that bonds (1) trade in large increments and (2) are difficult for most retail traders to transact and understand, assuring that unsophisticated investors can’t manipulate them.

The purpose of today’s post - the latest in my series entitled “everyone in the stock market thinks I’m a total dumbass” - is to point out another alarming divergence between the bond market and equity markets.

Forgive me if this is pedestrian for your understanding level, but almost everybody knows that yield curve inversion has preceded almost all recessions in history.

This chart from Axios shows that:

The idea is that, generally, yield curve inversion sends a signal to the market that investors are expecting rate cuts (hence why longer dated maturities price in lower yields than near term maturities, which reflect closer to the actual rate).

For example, if rates are 5% today, a 6 month Treasury bond could have a near 5% yield. But if a 10 year bond has a 3.75% yield, it’s an indication that in the time between the 6 month maturity and the 10 year maturity, the market expects the going rate of bonds to move lower. The bigger the spread between the two bonds gets, the more the market believes rates will diverge from where they currently are.

Despite history being very clear about recessions and yield curve inversion (again, see the chart above), Axios, like some others on Wall Street, have postulated that a move lower in rates would be the effect of deflation, and not necessarily a recession. They pointed out that “…analysts suggest that, rather than a recession, yields on longer-term bonds might instead be pricing in a sharp decline in inflation. That would mean the Fed could stop hiking (and maybe even start cutting) interest rates soon-ish.”

Nothing like having the best of both worlds, right? Rate cuts without a recession? Just hook it up to my bulging Keynesian veins! After all, something has to get PE ratios back to 50x!

The current debate about the market is whether or not the Fed is going to be engineering a soft landing anytime soon. The idea of a soft landing, which ostensibly means that the Fed would...(READ THIS ENTIRE REPORT HERE). 

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