A BOND MARKET REVOLT!

The Bond Market has begun revolting as the “Bond Vigilante’s” and Foreign Investors react to a new US Administration’s planned policies of heavy borrowing, without an accompanying credible economic growth plan. Treasury investors are worried that massive news borrowing will fail to go into sufficient productive assets which will pay for the elevated borrowing levels. Additionally they new loan levels making existing and rollover loans more risky. After less than 30 days of the new US Regime’s 57 Executive Orders they have seen enough and have begun reacting accordingly.

Consequentially, US Treasuries were a bloodbath Thursday as CNBC’s Rick Santelli called the 7Y auction the “worst auction ever”! It was the belly of the curve that massively under-performed. It came at the worst possible time – just as the curve was selling off on inflation fears. The In-directs plunged from 64.10% to just 38.06%, the lowest since 2014, as no foreigner suddenly wants to even smell US debt!

The result was an instant spike in 10Y yields, which blew out more than 10bps, surging as high as 1.61% before reversing some losses but still above the critical 1.50% nominal rate

• It has been the speed and size of the surge in yields that has spiked the MOVE Volatility Index (see Addendum below),
• A move higher in rates is now seen as a major threat to Growth and a Value rotation is noticeably occurring.
• Additionally, Real yields continued to surge – to their highest since June 2020 but still in negative territory at ~-0.6093%

“BELLY OF THE CURVE”

The unprecedented rout in the belly of the Treasury Curve saw Convexity levels breached. This chart below isn’t GameStop, Bitcoin nor Tesla – It is the 5Y UST!!!

Convexity, which prices Risk saw the critical 0.75% trigger level decisively breached on 5Y UST.

YIELD CURVE

YIELD CURVE HAS STEEPENED DRAMATICALLY

As the Yield Curve chart below shows, the yield curve as a consequence has steepened dramatically. Though this is good for bank profits it will impact mortgages and cash strapped consumers who still can’t return to work due to the pandemic.

With Chinese real rates so much higher we are seeing the bond carry trade moving into Chinese Bonds. Investors have confidence in a strengthening Yuan and are worried about continued weakness in the US dollar.

Will the Fed soon be forced into Yield Curve Control (YCC)? With US real rates already lower than most countries in the world (completely the opposite of this time last year) Bond Investors feel it is highly likely that continued low real rates plus YCC implementation will lead to US$ weakness. Considering the historic correlation of a steepening yield curve, the following chart is quite ominous!

TREASURY YIELDS

10Y UST NOTE

10Y Yields therefore also exploded higher as the auction debacle struck (surging from 1.47% to 1.61%) before ‘someone’ stepped in, attempting to push yields lower..

IS THE EQUITY MARKET ABOUT TO BREAK?

Many have been predicting that forecasts of US 10Y yields rising back to 1.5% “would prove too bearish as the equity market, and especially US tech stocks, would implode before we got there. Well we have broached that level and so far the markets only appear highly nervous with noticeably increasing volatility.

According to BCA’s Dhaval Joshi (chart to the right & below) a yield gap of 2% between the world Technology 12M forward Earnings Yield and the US 10Y Bond Yield should be the point at which the Tech sector would start to lead the overall equity market lower. That number as of close Thursday is ~3.52% (in red below)

CONCLUSIONS

• The Bond Vigilante’s are back! They can be expected to pressure Powell and Yellen in ways not seen since the 90’s,
• Foreigners are not buying the new US Policy direction!
• Though near term Inflation is solidly here, Bond Investors are telling the Fed they are equally worried about coming deflation associated with the Pandemic fallout of cascading Bankruptcies and the inability of the US to handle the associated debt failures and delinquencies.

“If bond yields continue to rise and there is a smooth rotation out of growth and defensive stocks into value and cyclical stocks, the Fed will remain sanguine.” But the risk is growing that “with so many bubbles blown by the Fed something will burst soon. And despite the widespread certainty that the Fed can micro-manage the equity market, and levitate it at will, the real shocker would be if the Fed lost control in any impending equity riot ….. “the real risk is that further monetary concessions won’t appease the mob and Fed control is lost. For as Jeremy Grantham reminded us recently, this bubble has now become as big as anything in history as will be the inevitable denouement.”

SocGen’s resident inhouse permabear, Albert Edwards