Welcome to the new week! January is almost over already.
Time flies when you’re not allowed to have any fun, it would seem…
I have recorded a short video for today’s note, as I felt it was imperative to be focused on the chart when discussing this theme.
In it, I take a look at the great fallacy that’s inherent in the argument that “the Fed will support markets” or that you “shouldn’t fight the Fed”.
With bond yields rising in the US, this fallacy may soon be exposed. Watch below to find out more…
Rising bond yields reflect rising inflation expectations.
And the Fed is openly trying to create inflation.
But the Fed can’t tolerate higher bond yields.
These three truths are on a collision course. How far will they get, and who will break first?
Will the Fed stop printing money to support “the economy”, because inflation is running hot and threatening to tank the financial asset markets?
If they truly don’t pay attention to such things, as they so often claim, then we have a deflationary crash on the horizon.
Or… do they act to forcibly suppress rates?
They can’t suppress them much longer with mere bond issuance, as the inflationary forces that unleashes is what’s pushing bond yields up in the first place (and hammering bond prices in equal measure).
For me, the ultimate irony is that people are buying into record-overvalued stocks based on the premise of lower rates for longer.
But it is the Fed’s actions which are now causing people to fear inflation once more, pushing rates higher.
And don’t forget – while you may want to point at the 2-3% rates which were present before the corona-crash, the situation is different now. The corporate and government worlds are much more leveraged, much more highly indebted, and much less capable of tolerating higher interest rate burdens.
There is always a threshold above which bond yields start to cause mayhem in financial markets. Because the interest burden gets too high, and swathes of borrowers are unable to pay.
We never know what that number is until it hits though. And the higher the debt mountain grows, the lower that threshold falls.
The Fed is stuck in a bind.
My base case for this year is that these rising inflation expectations show up first in bonds, then in stocks, causing both to sell off somewhere between quite a bit, and catastrophically.
The current trend in US government bond yields is a path to destruction, if the Fed continues to act as it is today.
Its only way out is a little-known phenomenon, identified most clearly by the analyst, Russell Napier.
It’s called Financial Repression, and involves government acting to put caps on rates of various kinds.
Rates are forcibly kept at low levels, by decree rather than by market weighting, regardless of inflation pushing higher.
Whether equity markets can see through this ruse will determine whether they blissfully and very ignorantly carry on climbing higher based on the idea that low bond yields make equities look more attractive, relatively.
Alternatively, where once commentators opined that the truth can only be found in the bond market, it will be in equities where reality is better reflected.
By dramatically lower prices.
Best of luck, Jerome and co.
And best of luck to you too, because it will not be an easy time to be investor.
An open mind and a sceptical approach may be required.
Luckily, I’m here to help.
All the best,
Editor, UK Uncensored