It’s All About the Bonds

Today again is all about global interest rates, mostly on the long end. A lot was made about what Eric Rosengren said on Friday but rate hike odds for September still only reached 28% afterwards. The 2 yr note yield is basically where it was two Friday’s ago. We closed out the day with certain relief on the part of some that Lael Brainard killed the chance of a rate hike next week (2 yr note yield interestingly though is only down 1 bp). Stocks are of course celebrating. I again will highlight my belief that the real story for markets from here will be where longer term rates go. The 10 yr yield is basically unchanged from Friday’s close and thus is holding the recent move higher (it touched 1.52% the day the ISM services index hit a 6 ½ year low) to the highest in almost three months. The weak 10 yr auction today, notwithstanding the highest yield since June, is noteworthy. The bid to cover in this auction was just off the lowest level in 7 ½ years.

I said a month ago that something was amiss in Japanese JGB’s and that I believe is the genesis for this uptick now globally in rates, not whether the Fed may raise 25 bps or not. Not that it would not be a big problem though for markets, especially after the string of weak economic data. We know that buying bonds with a negative yield or anything close to zero is just a game of hot potato as these bonds are not assets of the buyers, they have become liabilities. Thus, when the selling occurs, the moves could be sharp and would of course impact more than $10T of negative yielding securities, let alone another $10T of bonds yielding between zero and 1%.

With respect to what we are now seeing with bond yields and central banks, it is all about control. Control of what they want to bully. When things are perceived to be under control, confidence in asset prices are a result. Once that control gets questioned, confidence slips and asset prices become very vulnerable. The Japanese have lost control of the yen, its stock market and now maybe the long end of their curve (which they may intentionally want to see go steeper). Japan is the epicenter of monetary intervention in terms of its size and manipulation and I’ll say again we should go to bed each night and awake in the morning looking to see what the JGB market is doing.

With respect to stocks, let’s not kid ourselves, near record highs is not a reflection of the earnings outlook and the state of the US and global economy. It is all about the level of interest rates and the money printing. If bond yields start to reprice, stock prices with the current extreme valuations have much further to go in what is MAYBE the beginning of a broader selloff. How many times have you heard ‘stock prices are attractive considering the level of interest rates’? Well, if bonds are in a massive bubble, what does that say about stocks?