In a nutshell, the market is now focused on one thing and one thing only, or so it seems to the breathless media.
Bond-Market Game of Chicken With Fed Is Riskier Than Ever
Man-oh-man, the Fed has a tight hold on the market. The problem as I see it is the market is holding right back with white knuckles.
- Investors are yanking cash out of the fixed income market. Government bonds experienced a sixth-straight week of outflows. Emerging market debt, a big beneficiary of extremely low U.S. interest rates, suffered the biggest outflow in nearly five months.
A preemptive strike on bonds is the market acting out its fear. Bonds are the basis of debt, and right now there is some $50 trillion (with a T), which means that if bond yields rise too high too quickly, investors will lose money and debt will become more expensive.
- And the stakes have never been higher for holders of debt globally, who are more exposed to the potential for big losses than at any time in history, based on a metric known as duration.
Keep in mind, as yields rise, the cost of the underlying bond goes down, so reselling the bond becomes more difficult. Yup! There it is, one of the huge underlying issues for the financial crash of 2008 was repackaging and reselling debt, particularly mortgage debt.
- If yields on 10-year Treasuries rose to 3 percent by year-end, investors today would face losses of 3.6 percent, data compiled by Bloomberg show.
So, the bond market sells off to the tune of $1.2 trillion (with a T) because bond holders fear losses, or, at the least, they fear having their money tied up for years in bonds that could lose them money (in real terms) if inflation rises higher than the return on the bond.
Yet …
- The good news is the stock market weathered the storm admirably. The S&P 500 retreated less than 1% last week and remains in striking distance of all-time highs.
So, the market is acting out regarding the Fed’s pending actions on interest rates, but it is not freaking out. As I said last week, the market wants to go up, but the Fed thing is a weight, which, in the end is a good thing, as long as the market does not panic.
- “The market isn’t going bonkers,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.
The reason the market is not “going bonkers” is, as I also said last week, the market ultimately trades on fundamentals, and the market understands this
- For all the hand-wringing over the recent selloff that wiped out about $1.2 trillion in value from the global bond market, the fixed-income market’s best and brightest have actually taken down their year-end estimates for Treasuries in four of the past five months.
So, I expect the preemptive selling to abate, as the market comes back to reality, but in the meantime, consider another the possibility for the bond-market exit.
Imagine for a moment that the debt market has been hot ($50 trillion), so buying and reselling debt is a moneymaker. Now suppose smart investors see that market diminishing. What would they do? You got it.
- Bonds sell-off = better economy: The reason is simple: Investors realize that a good economy can be good for businesses (and stocks) too.
Yup! It could be investors are setting up shop for an equity investment big time. It could be investors are seeing the six-year bull market in equities going on for some time. In fact, they might be seeing the greatest bull market in history coming, and why not?
- Incredibly, the 5.6million jobs created in the past 24 months is greater than the combined total created in the 13 years before.
- It’s not just the labor market that looks better. Closely-watched auto sales revved to the best pace since 2005 in May despite lingering concerns about consumer spending.
Again, the breathless media and the talking heads favor the worst, but in reality, there is no fundamental reason to suspect the market will crash when the Fed actually raises interest rates. In fact, there is reason to suspect it will just the opposite, as the underpinnings for the US and global economies are not only sound, they are forward looking, as is the market.
- Even if robot autos are still a way off, manufacturers are adding more and more systems that can take the wheel in certain situations. The lure for automakers is clear. Demand for features that ease the more tedious aspects of driving, such as steering through stop-and-go traffic, could create a $42 billion market by 2025
The Digital Revolution is now solidly in place and the benefits to consumers and businesses are in plain sight. More jobs equals more profit, and more profit means the market wants to go up.
Trade in the day; invest in your life …
