What Happened?

Could everything have changed in a 24 hour period? Apparently, Yes, Over the span of 24 hours markets woke up and realized that the FED may be at the cusp of committing Policy Error. Recently bonds have been teetering on the edge and this week Jerome Powell gave bonds a push off the ledge. Bonds delivered a message and the stock market was listening. Stocks got derailed along with bonds.

Yields blew out and sucked the air out of the stock market. So why the big move in bonds? Two reasons:

  1. Less demand for LT bonds due to the higher cost of hedging caused by higher yields, higher USD and emerging markets dropping.
  2. FED Chair Powell advertising he plans on being very aggressive with rates. He plans on raising rates until something breaks.
  3. The market interpreted Powell’s remarks as Policy Error. Market players know that when something does break the FEDs policy response will likely be too slow, they will lose their grip and risk assets will crater. That’s what happened this week.

Just Another Step along the Post Bubble Contraction Highway

That’s what this is, it’s the initial shock from around the world finally reaching the world’s financial center. All year long we have seen foreign markets diverging away from the USA. Capital flows towards the center have made the US seem impervious to any problems outside the inner core:

In the course of 24 hours everything changed. Using Warren Buffets quip, it’s now time to find out who has been swimming naked! In our last PBC report I showed how Ray Dalio has publicly come on board to the PBC model. Since then the Stanley Drukenmiller interview hit the internet where he espoused these same concepts. Stan pointed out how the markets are filled with naked zombies floating around waiting to blow up once liquidity is withdrawn and rates begin to rise. This is all part and parcel of the PBC. So this week the markets visibly took the next step down the PBC highway.

This Week’s Big Story- Rate Shock

Before I show some charts let me say I remain firmly planted in the Lacy Hunt school of interest rates. This week I attended his presentation at the Stansberry seminar in Las Vegas where he updated his views on the course of interest rates in a PBC. Bottom line is one should expect rates on the long term 30 year US Government bond to continue to trend lower over the next 10-20 years. This of course is a non consensus view, but based on sound analysis and history. Therefore the pop in rates we are currently witnessing is temporary and eventually will reverse back downward. It is difficult to reduce a one hour explanation into a few bullet points, but I will try:

  • The over use of credit (FED QE) is subject to the law of diminishing returns, therefore the productivity of debt ultimately decreases the velocity of money.
  • Slowing money velocity leads to lower inflation over time. (this has been occurring for 20 years now)
  • The long bond yield is a reflection of the inflation rate.
  • When economic growth rates are below secular trend (it has been for 10 years now) you get lower inflation and lower bond yields
  • Synchronized Global Monetary deceleration is now occurring everywhere in the world which will lead to decelerating economic growth