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What the bond rout is telling us

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Good Morning. This week is packed with a drop in Federal Reserve data and speeches, which are set to cause exciting or exhausting changes in intraday prices. Today we are looking at falling bonds, and going on a late trip to the land of crypto. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Bond Sale: Tightening the Fed or Changing Regimes?

The big story in the markets remains the bond sale, which stemmed from the US Federal Reserve’s severe hawkish turnaround.

  • The Treasury’s 10-year yield rose by a dizzying 78 basis points, to 2.48%.

  • The Ministry of Finance for two years rose by a huge 98 basis points, to 2.28%, which leaves the yield curve of 10/2 close to reversing. Although the 10/2 curve is not nearly as good as the 10/3 month curve in a recession forecast, it is almost as good at scaring people.

  • The five-year inflation balance rose by 45 basis points to 3.59%.

  • Market expectations for raising the Fed interest rate have risen. The main forecast – weighted with a 65 percent probability – is eight or nine increases of 25 basis points by the beginning of 2023. An increase of 50 points is widely expected at the May meeting.

The net result was a complete whipping for the finance ministries in relation to shares:

As we have mentioned several times before, a return to a (relatively) normal tariff environment has always been dismal, so it is important to maintain perspective. However, the shameful possibility that a concentrated tightening of the Fed may tilt the market into should be considered low tide. Don Reshiller from Stregas gives a typical summary: “The Fed is now in a ‘tightening position until something breaks’. The key question remains whether it’s inflation or growth that breaks first.”

In other words, the U.S. economy is very advanced at the moment, with unemployment claims at a half-century low. burst. All of these things can hurt the lagging economy, meaning they can bite just as the economy began to weaken anyway.

For now, the market is betting that the Fed will thread the needle, tightening enough to keep inflation under control without causing a recession. There are four indicators for this:

  • The 10/2 curve remains positive, and the stronger prognosticator, the 10/3 month, is positive Wide.

  • While corporate bond yields are rising, their spreads on bonds are still below pre-plague levels. If they were pricing a higher risk of recession, you would expect from junk spreads more than that:

Line chart of the ICE BofA High Yield Index in the US
  • The stock, although off-peak, has risen respectably in the past two weeks, and valuations are still higher than reasonable if a recession is even a minor option in the near future.

This last point is a bit smooth. Citigroup’s equities strategy team in the US notes that historically there has been little link between Fed policy direction and stock performance.

Since the 1970s, the correlation between variable feed funds and S&P 500 returns has been almost zero. The problem is the effect of the push and pull of the “P” (valuations) and “E” (earnings) motives of the markets. The tightening of the Fed is consistent with a decrease. The S&P 500 P / E showed a moderate negative correlation to changes in long-term funded funds. Stricter policies generally push investors to assign a lower “P” to index gains. Nourished rising funds are settling with better growth. The positive correlation of the S & P 500’s earnings growth to the path of funded funds is stronger than the negative valuation ratios. Lower duplicates during Fed tightening are usually activated on an ascending “E”.

That sounds right, as far as it goes. But remember the usual pattern into which these things fall. In one part of the cycle, the economy is hot, profits are rising, stocks are successful, and the Fed is tightening. In the next section, the Fed sees signs of an economic cooling, in parallel with a slowdown in earnings growth, and stops tightening. This is the third step that is causing trouble: the economy and profits continue to slow down, the Fed is starting to cut back. . . But it is too late, followed by a recession. Sometimes (like in the early 90s) this third stage never happens. But it often happens.

So yes, there have been some instances, as City emphasizes, where the Fed’s tightening has coincided with a rise in stocks. However, what is most important to investors is whether there will be a recession, and if so how quickly; A recession is terrible for stocks. Below is Citi’s chart of the year-on-year change in S&P and Fed rates. The gray stripes are a recession. Unhedged has added our usual neat circles around moments of simultaneous increases in rates and stocks.

Stocks, in short, sometimes receive the recession memo late. Still, even if the stock’s current strength is only modest consolation, the yield curve and bond spreads remain significantly calming.

But what if something bigger than the standard interaction between tariffs and the business cycle happens? Michael Hartent, of Bank of America, thinks the bond sale is not just about tightening the Fed. It’s also a sign of regime change. He’s slicing his portfolio in a cropped style:

2020 secular lows for inflation and yields – the third bear bond market on the way; The previous large bears were 1899 to 1920 and 1946 to 1981; Deflation to inflation, globalization to isolation, excess from monetary to fiscal, capitalism to populism, inequality to generalization, the humiliation of the US dollar. . . Long-term yields above 4 percent in 24 ‘.

> +10 percent of stocks and bonds of recent decades are expected to fall to yields <3-5 percent in the long run at best; Higher volatility in bonds, currencies and stocks.

While the “geography of capital” favors U.S. stocks in the near term (investors face a shrinking geographic opportunity set as countries and asset types to invest in security of safety and liquidity), technology is the new secular for sale for strength (probably the worst performance sector of the 1920s) When bond yields rise in the medium term and central bank liquidity shrinks

The two historical bear markets to which the retent suggests are easy to see in this chart:

This is what is known as a big read, and we are not sure how we feel about it. Artent is not the only one who thinks that the deflationary forces that have defined the last four decades, and which we may loosely group under the heading “globalization,” are rapidly dissipating. Charles Goodhart and Nuriel Rubini, to name just two, have largely similar views.

We find this forecast, which calls for a long bear market in bonds, a bit difficult to get along with the idea (with which we agree) that the basic interest rate of the economy (“Star R”) continues to fall. A lower R star implies that the Fed can only rise so far, what Which also limits returns. But there is a lot to think about here. (Armstrong II)

Etherium and energy

Crypto has, at the very least, a bad brand. Associations with speculation and fraud are forged. Worse, issuing most cryptocurrencies is an energy-intensive process. Common conclusion: Using the energy emitted by greenhouse gases to create a device for fraud and speculation is a bad idea.

Aside from fraud and speculation, the long-awaited solution to Atherium’s high energy consumption is expected to come out in the coming months (though it has been delayed in the past). The basic idea is to renovate the way new sites are embedded. A mostly successful beta test on March 15 led to a week of Atherium Better performance Bitcoin.

When the current system asks “miners” to devote heavy computing power, the proposed new system will instead require “finishers” to publish their tokens as collateral in exchange for a return. The result of the move to “proof of bet” will be to cut the grid’s power consumption by orders of magnitude.

A successful transition to Atherium will be embarrassing for Bitcoin. Since both currencies make up over 60% of the total market value of the crypto, the energy problem of the crypto will become mainly bitcoin. so Bitcoins Went on the attack. Ethereum’s new system, they say, is undermining decentralization.

Ethereum production under proof of betting will empower the wealthiest site owners, it has been argued. Contestants must lock in a minimum of 32 sites, valued at $ 105,000 at current exchange rates. And although there are side applications to let smaller fish shoot (and earn a return), control will be very concentrated among whales.

I think this review is true, but maybe it does not matter. The role of crypto b Transfer of donations LaUkraine launched the sector to new heights, even got a nod to confirm Larry Pink’s BlackRock Last Week. Crypto’s breakthrough into mainstream funding, whatever it may look like, may be approaching. But mainstream financing is not an industry that is bothered by concentration at the top. In strict business terms, Ethereum’s choice of energy efficiency over decentralization seems smart. (Ethan Wu)

One good read

Nice connect From our colleague Brock Masters on asset managers rushing to “alternative investments”. The explanation for the trend is that “altars” bring higher commissions. It remains to be seen whether they lead to higher performance or true diversity.

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