Category: Fixed Income

Treasury, municipal and corporate bonds

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Inflation dips?

The 10-year Treasury yield retreated after the release of December CPI data, with breach of the rising trendline signaling a correction to test support at 4.5%.

10-Year Treasury Yield

However, the monthly chart below shows the long-term uptrend is unchanged, with the 10-year yield expected to reach 5.0%. Breakout above resistance would warn of an advance to 6.0%.

10-Year Treasury Yield

CPI Inflation

Core CPI (ocher) dipped slightly to 3.2% for the twelve months to December, while headline CPI (red) increased to 2.9%, holding stubbornly above the Fed’s 2.0% target.

CPI & Core CPI - Annual

Monthly data shows a sharp spike in headline CPI in December, increasing at an annualized rate of 4.7%. Core CPI, however, slowed to 2.7% (annualized).

CPI & Core CPI - Monthly

Energy

The difference is energy costs, excluded from core CPI, which jumped 2.63% in December, warning of rising energy prices in 2025. The December increase equates to an annualized rate of more than 30%.

CPI Energy

Energy prices are a key vector for transmitting inflation. Prices rise steeply during a boom as expanding demand outstrips inelastic supply, and the opposite occurs during a recession when falling energy demand causes a surplus. Energy prices (orange below) rose ahead of headline CPI (red) in 2021 and fell ahead of its subsequent decline in 2022 – 23.

CPI & CPI Energy - Annual

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Services

CPI for services (excluding shelter) was a low 0.099% in December or 1.2% annualized. Services generally indicate more persistent inflation, so the Fed will likely treat this as a win.

CPI Services excluding Shelter Rents

Long-term Inflation Outlook

Long-term inflation expectations are rising, with the University of Michigan 5-year outlook climbing to 3.3%.

University of Michigan: 5-Year Inflation Expectations

We do not anticipate a significant hike in CPI in early 2025, but there are warning signs of a rebound.

Brent Crude

Brent crude has climbed to above $80 per barrel on fears that new sanctions on Russian shipping will impact supply. Retracement that respects support at $80 would confirm another advance.

Brent Crude

Stocks

Mega-cap technology stocks rebounded from yesterday’s fall, with the two most volatile Nvidia (NVDA) and Tesla (TSLA) showing gains.

Top 7 Technology Stocks

The S&P 500 index recovered above resistance at 5850, indicating another test of the high at 6100.

S&P 500

Large caps also enjoyed support, with the equal-weighted index ($IQX) testing resistance at 7200. Breakout would indicate another test of 7600.

S&P 500 Equal-Weighted Index

Growth stocks rebounded from their recent sell-off relative to defensive stocks. However, the Russell 1000 Large Cap Value ETF (IWD) has outperformed the Russell 1000 Large Cap Growth ETF (IWF) over the past month.

Russell 1000 Large Cap Value ETF (IWD) & Russell 1000 Large Cap Growth ETF (IWF)

Financial Markets

Bitcoin is again testing resistance at $100K. Reversal below $90K would warn of a liquidity contraction likely to affect stocks and bonds, but there are signs that financial conditions are easing. Breakout above $100K would confirm.

Bitcoin (BTC)

Expanding liquidity is partly attributable to a $350 billion fall in Fed overnight reverse repo operations in January after an equally sharp rise in December caused a contraction.

Fed Overnight Reverse Repo Liabilities

The Chicago Fed National Financial Conditions Index declined to -0.63 on January 10, suggesting similar financial easing to 2021.

Chicago Fed National Financial Conditions Index

Moody’s Baa corporate bond spread has also narrowed to 1.44%, the lowest since the 1990s, which indicates ready credit availability.

Moody's Baa Corporate Bond Spreads

Gold

Fears of persistent inflation drive gold and geopolitical tensions fuel further demand. A higher Trend Index trough indicates rising buying pressure and a breakout above $2,725 per ounce would signal another test of $2,800.

Spot Gold

The monthly chart below shows the long-term view, where breakout above resistance at $2,800 (green) would offer a target of $3,600.

Spot Gold

Conclusion

Our three pillars supporting financial markets are 10-year Treasury yields, crude oil prices, and financial market liquidity.

Financial market liquidity is strong and supports demand for stocks and bonds with easy access to leverage.

Crude oil prices have been subdued since 2023, with strong production from non-OPEC+ producers (especially the US) and weak demand from China. However, geopolitical tensions now threaten supply, with Brent crude rising above $80 per barrel. The risk is that higher energy prices cause a resurgence of inflation and drive up long-term interest rates.

Inflation concerns over a tight labor market were temporarily allayed by December’s weak core CPI and services CPI growth. However, rising energy costs will likely increase input costs, causing a rebound in the months ahead. Market concerns over inflation are expected to grow as the incoming administration attempts to stimulate an economy already at close to capacity. The 10-year Treasury yield may briefly retrace to test support but is then likely to continue its long-term uptrend. Breakout above 5.0% would offer a target of 6.0%, which would be bearish for stocks and bonds.

We are underweight growth stocks trading at high earnings multiples and are avoiding financial instruments with a duration longer than two years.

Gold will likely benefit from a higher long-term inflation outlook and rising geopolitical tensions. We are overweight gold and defensive stocks trading at reasonable multiples relative to earnings.

Acknowledgments

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Fed shock – really?

Stocks plunged on indications that the Fed would slow further rate cuts after announcing a 25-basis-point cut at the FOMC press conference on Wednesday.

Really? That could be seen coming for months. The economy has proven resilient, unemployment is low, and retail sales are growing. The obvious question is: “Why cut rates at all?”

FOMC Decision

As expected, Chairman Jerome Powell announced a 25-basis-point rate cut, lowering the fed funds rate target to 4.25% to 4.5%.

Financial markets were spooked by the sharp jump in FOMC projections for rate cuts next year. The Dot Plot now centers on a further 50 basis points of rate cuts in 2025, a target range of 3.75% to 4.0%.

FOMC Dot Plot

Compare that to the September projection below, which was equally divided between 100 and 125 basis points of cuts next year, a range of 3.0% to 3.5%.

FOMC Dot Plot - September

Powell explained that:

  • The economy is “strong” and has made good progress towards the Fed’s goals.
  • The job market has cooled but remains “solid.”
  • Inflation continues to move towards the Fed’s 2% target.

The Fed Chair provided further background in answers to reporters’ questions:

  • “We feel that slowing the pace of future adjustments seems prudent now, especially as we expect inflation to be stickier than we initially thought.”
  • “Some FOMC members did cite future inflationary fiscal policy as a concern.”
  • “Most forecasters keep calling for a slowdown in economic growth, but we haven’t seen it yet and don’t see one happening soon. The US economy is doing great.”
  • “We’re not too worried (about loose financial conditions). Both inflation and labor have cooled, so our policy is working. Financial conditions aren’t impeding us.”

Fed Balance Sheet

Powell announced that QT would continue at the same rate, but the rate offered on reverse repo (RRP) would be lowered, which may encourage further money market outflows into the T-Bill market. Total Fed holdings of Treasuries and mortgage-backed securities (MBS) have fallen by $1.9 trillion since their peak of $8.5 trillion in 2022.

Fed Balance Sheet: Treasuries and Mortgage-Backed Securities (MBS)

Only another $6.0 trillion to go. 😟

Treasury Markets

Ten-year Treasury yields jumped. Breakout above resistance at 4.5% would offer a target of 5.0%, which would be bearish for stocks and precious metals.

10-Year Treasury Yield

Stocks

The S&P 500 plunged to support at 5860. Breach would signal a test of 5700.

S&P 500

Tesla (TSLA) dipped sharply after a spectacular two months, peaking at +117%, compared to Nvidia (NVDA) at -6.6%.

Top 7 Technology Stocks

The weekly chart of the equal-weighted S&P 500 index ($IQX) shows a breach of support at 7150, likely headed for a test of 6900. The lower Trend Index peak identifies selling pressure but is still above zero, indicating that the primary trend remains intact.

S&P 500 Equal-Weighted Index - Weekly

Financial Markets

The Chicago Fed National Financial Conditions Index dipped to -0.66% on December 13, indicating “loose” monetary conditions. Moody’s Baa corporate bond spreads are also at a thirty-year low, reflecting easy credit conditions.

Chicago Fed National Financial Conditions Index & Moody's Baa Corporate Bond Spreads

Bitcoin retraced to test support at $100K, but the strong uptrend still signals abundant financial market liquidity.

Bitcoin (BTC)

Dollar & Gold

The Dollar has strengthened in response to rising Treasury yields, with the Dollar Index breaking resistance at 108.

Dollar Index

The Bank of Japan may be forced to raise interest rates again to support the Yen, which could cause an outflow from US financial markets as carry trades unwind.

Japanese Yen - Weekly

Gold broke support at $2,625 per ounce, signaling a test of primary support at $2,550.

Spot Gold

The long-term uptrend, shown on the weekly chart below, remains intact.

Spot Gold - Weekly

Silver similarly broke support at $30 per ounce, but a breach of primary support at $26.50 remains unlikely.

Spot Silver - Weekly

Conclusion

The Fed is riding a wave of deflationary pressure from the global economy, led by China. The bear market in crude oil and copper signals that global demand is contracting. Low inflation should enable further rate cuts next year, but the pace will likely slow as the Fed is wary of a resurgence in domestic demand.

The prospect of inflationary economic policies from the new administration could set off a public feud between Donald Trump and the Fed chairman. Stimulating an economy that is already close to full employment would force the Fed to hike rates to ease inflationary pressures, attracting the ire of the new president.

US financial markets, with rising long-term Treasury yields, are sucking up global liquidity and more than offsetting Fed tightening (QT). The strong Dollar increases pressure on international borrowers in the Eurodollar market as domestic exchange rates weaken. The Bank of Japan may also be forced to hike interest rates again to support the Yen, causing further unwinding of the carry trade and outflows from US financial markets.

The S&P 500 is overdue for a correction, but the primary uptrend is unlikely to reverse unless there is a sharp contraction in financial market liquidity.

Gold and silver are undergoing a sharp correction, but the primary uptrend remains intact. Two long-term fundamental trends support precious metals. First, central banks are increasing their gold reserves and reducing currency reserves as the global sovereign debt bubble expands. Second, in response to a collapsing domestic real estate market, Chinese investors are switching focus to gold and silver as a store of wealth.

Acknowledgments

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The last guardrail

In the above ABC interview, Professor Nouriel Roubini said it would be interesting to watch Trump deal with financial markets:

He said if Trump was “really serious” about 60 per cent tariffs on China, and 10 to 20 per cent tariffs on other trading partners, about sharply weakening the value of the US dollar, about “draconian restrictions” on migration and “mass deportation”, and about tax cuts that weren’t funded by raising other taxes or cutting spending, it could lead to situations Trump wouldn’t like.

“If he tries to follow these policies that are stagflationary, interest rates are going to be much higher, bond yields are going to be higher, the Fed will have to raise rates rather than cutting them, the stock market is going to correct,” he said.

“He cares about the bond market. He cares about the stock market. And therefore market discipline, as opposed to political discipline … [will] be the main constraint [for him].”

Long-term Treasury bonds continued their downtrend after November 5.

iShares 20+Year Treasury Bond ETF

Ten-year yields are testing resistance at 4.5%. A breakout above 4.5% would likely cause a correction in stocks.

10-Year Treasury Yield

Fears of rising inflation are not the only factor driving Treasury yields higher. Since 2020, Treasury issuance has been skewed towards short-dated T-bills, with the issuance of notes and bonds (green) kept as low as possible to suppress long-term yields.

Treasury Issuance

A study by Hudson Bay Capital concluded that rolling back the excess $1 trillion in T-bill issuance would cause a 50 basis point rise in the 10-year yield—equivalent to a 2.0% rise in the Fed funds rate—before settling at a permanent 30 basis point increase.

Also, Fed QE almost exclusively focused on purchasing notes and bonds to keep long-term yields as low as possible. Reducing the Fed’s balance sheet through QT increases the supply of notes and bonds, driving long-term yields higher.

Fed Holdings of Treasury Notes & Bonds and T-bills

Rising long-term yields constrain the S&P 500, which is testing support at 5850. Breach would signal a correction to 5700.

S&P 500

Financial Markets

Bitcoin remains above 90K, signaling strong liquidity in financial markets.

Bitcoin (BTC)

Dollar & Gold

The Dollar index retraced to test support at its rising trendline, but breakout above 107 remains a threat, offering a target of 115.

Dollar Index

Gold rallied off support at $2,550 per ounce. Penetration of the descending trendline at $2,650 would indicate a base forming.

Spot Gold

Silver similarly found support at $30 per ounce.

Spot Silver

Energy

Brent crude remains in a bear market, which is likely to keep inflation in check as long as global demand remains subdued.

Brent Crude

Base Metals

Copper also reflects weak global demand, with another likely test of support at $8,600 per tonne.

Copper

Conclusion

Donald Trump’s election campaign was based on reviving a “weak” economy, which has proved surprisingly resilient. The Fed and Treasury succeeded in taming inflation without crashing the economy—a rare feat. However, their efforts have built up imbalances in the financial system that lie in wait for the unwary.

Stimulating an economy already close to full employment will inevitably cause higher inflation, preceded by a surge in long-term Treasury yields. The result would be a sharp fall in stock prices and a likely recession.

The Republican party may control the House and the Senate, but the final guardrail is the bond market. They ignore that at their peril.

Gold and silver fell as the Dollar soared in response to higher long-term Treasury yields. But yields are rising in anticipation of rising inflation. We remain bullish on gold and retain our $3,000 per ounce target.

Acknowledgments

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China sizzle turns to fizzle

China’s announcement of economic stimulus and hints at an even larger “bazooka” ahead caused a sizzling rally on the Shanghai exchange, with the CSI 300 leaping 20% in the last week of September.

Shanghai Shenzhen CSI 300 Index

Hong Kong’s Hang Seng Index displays an even steeper rally.

Hang Seng Index

However, a failure to follow through this week with sufficient detail of the stimulus package caused the rally to fizzle, with a sharp correction on both indices. Today, the Hang Seng is testing support at 20500.

China Stimulus

Crude Oil

Brent crude reversed sharply as prospects faded for a demand recovery in China.

Brent Crude

Treasury Markets

Ten-year Treasury yields stalled and will likely re-test new support at 4.0%.

10-Year Treasury Yield

According to the theory of interest developed by Swedish economist Knut Wicksell, the equilibrium or natural rate of interest—at which inflationary and deflationary pressures are in balance—is when the cost of borrowing is higher than the average return on new investment. This means that the 10-year Treasury yield–the risk-free rate–should be roughly equal to nominal GDP growth, approximating the return on new investment. The chart below shows that the 10-year Treasury yield, at 4.0%, is significantly lower than nominal GDP growth of 5.7% for the 12 months ended in Q2.

Wicksell Analysis: Nominal GDP Growth & 10-Year Treasury Yield

With the economy showing little sign of slowing, the likely outcome is either higher long-term interest rates or a build-up of long-term inflationary pressure.

Stocks

The S&P 500 gained almost 1.0% on Tuesday, with a shallow retracement and rising Trend Index troughs signaling buying pressure.

S&P 500

Nvidia led the advance of mega-cap stocks, breaking above its August high, while all seven advanced yesterday.

Top 7 Technology Stocks

The equal-weighted index lagged as large caps failed to match mega-cap gains.

S&P 500 Equal-Weighted Index

Financial Markets

Bitcoin continues to test the upper border of its trend channel. A breakout would be a bullish sign for financial market liquidity.

Bitcoin (BTC)

Dollar & Gold

The Dollar Index is expected to retrace to test new support at 102. Respect would confirm an advance to 104.

Dollar Index

Gold is headed for a test of support at $2,600 per ounce, but respect will likely confirm a re-test of $2,700.

Spot Gold

Silver is testing support at $30 per ounce, with respect again likely to signal a re-test of resistance at $32.

Spot Silver

Metals

Copper retreated in response to China’s disappointing stimulus. Expect a correction to test support at $9,250 per tonne.

Copper

Iron ore also reflects disappointment, retreating to $106.30 per tonne.

Iron Ore

Conclusion

A disappointing lack of detail on China’s newly announced stimulus led to a retreat in Chinese stocks and global crude oil, copper, and iron ore.

Ten-year Treasury yields are expected to retrace to test support at 4.0%. While yields are likely to remain low as the Fed cuts interest rates, the long-term equilibrium rate is expected to be higher—between 5% and 6%.

Respect of support at 5650 on the S&P 500 confirms our year-end target of 6000, but the advance is exceedingly narrow and precarious.

Gold is headed testing support at $2,600 per ounce, but respect is likely and would signal a re-test of $2,700.

Acknowledgments

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Harley Bassman | The MOVE Index

The MOVE Index has jumped to the fore as the best measure of financial market volatility. While the VIX measures volatility in equity markets, the equivalent MOVE Index measures volatility in the far larger bond market which as a better track record as a leading indicator of the economy. Here are some quotes from MOVE creator Harley Bassman that explain how the MOVE works:

The MOVE and the VIX are very similar in that they basically measure short dated one month volatility. The key thing is that these indices are mostly coincident indicators as opposed to forward looking, because they tend to track realized volatility……

When you have a very steep [yield] curve, so a two year of, call it two, and a 10 year of four, that creates a forward rate that’s much higher than today.

When we get that, the steeper the curve or the more inverted, the bigger the distance between today’s interest rates and tomorrow’s interest rate. Time only goes one way. So the future becomes the present, which means that forward rate got to come to the spot, today’s price, or today’s spot price has to go up to the future price. The bigger the distance, the bigger the spread, the more movement there has to be, and therefore the more uncertainty you have; and the price of uncertainty is implied volatility. (ICE.com)

MOVE Index

As the creator of this Index, let me say that both 50 and 150 are the “wrong number”. A level near 50 can only occur when the FED actively constrains risk, while a level near 150 occurs when the FED has lost control. The MOVE at 150 infers interest rate changes of about 9.5bps per day, a volatility that is unsustainable if only because human beings cannot tolerate such stress for long periods of time. (ConvexityMavens.com)

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The bond market revolt

The rise in Treasury yields accelerated over the past week, with 10-year Treasuries closing at 1.54% on Thursday and 10-year TIPS at -0.60.

10-Year TIPS & Treasury Yields

A sharp fall in daily new COVID-19 cases has fueled optimism about a rapid re-opening of the US economy.

USA: Daily New COVID-19 Cases

As well as fears of higher inflation.

10-Year Breakeven Inflation Rate

What the sell-off means

Investors are selling Treasuries at a faster rate than the Fed (and banks) are buying, out of fear of accelerating capital losses. Fixed coupons have been badly affected, with iShares 20Year+ Treasury Bond ETF (TLT) showing a loss of 13% over the past 6 months. But even inflation-protected bonds have lost value in anticipation of higher real interest rates, with PIMCO’s 15 Year+ TIPS Bond ETF (LTPZ) falling more than 6%.

20 Year+ Treasury Bond ETF (TLT) & 15 Year+ TIPS Bond ETF

The Fed response

The Fed is likely to respond by weighting purchases towards longer maturities. The 10-year Treasury yield has already started to anticipate this, falling to 1.39% by Friday’s close.

10-Year Treasury Yields

Source: CNBC

The result is a 16 bps fall in the real 10-year yield, to -0.76% on Friday (1.39-2.15).

Conclusion

Fed purchases are expected to suppress long-term Treasury yields over the next few months, with inflation breakeven rates continuing their upward trend, while real yields remain negative.

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Gold, low interest rates and volatile currencies

Gold is in a primary up-trend, after ranging sideways for several years, fueled by low interest rates and volatile currency markets.

The chart below highlights the inverse relationship between gold and 10-year Treasury yields. When LT interest rates fall, the gold price surges.

Spot Gold in USD compared to Real 10-Year Treasury Yields

At present, 10-year Treasury yields are close to record lows, testing long-term support at 1.50%.

10-Year Treasury Yields

Yields in Germany and Japan are much lower, having crossed below zero, and the opportunity cost of holding physical assets such as Gold is at record lows.

Negative Bond Yields in Germany & Japan

Volatility in currency markets is another factor driving demand for Gold.

China’s Yuan is testing support at 13.95 US cents. Breach is likely, especially if US-China trade talks break down again, and would signal continuation of the primary down-trend. A weak Yuan fuels Chinese demand for Gold.

CNYUSD

The Dollar Index continues to edge higher, boosted by the current trade turmoil. A strong Dollar is likely to weaken demand for Gold but Trend Index peaks below zero warn of selling pressure.

Dollar Index

Gold is testing support at $1495/ounce. Breach would warn of a correction, while breakout above the descending trendline would indicate another advance.

Spot Gold in USD

Silver is similarly testing support. Breach of $17.50/ounce would warn of a correction.

Spot Silver in USD

The All Ordinaries Gold Index is trending lower. Breach of 7200 would warn of another decline, with a short-term target of 6500, while recovery above 8000 would suggest another advance.

All Ordinaries Gold Index

Patience is required. Gold is in a long-term up-trend, with a target of the 2012 high at $1800/ounce. A correction would offer an attractive entry point.

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S&P 500: Donald Trump and the next recession

Treasury yields continue to fall, with the 10-Year testing long-term lows at 1.50%. A sign that investors are growing increasingly risk averse.

10-Year Treasury Yields

Crude oil prices remain weak; a bearish signal for the global economy. Breach of support at $50/$51 per barrel would warn of a decline to $40.

Nymex Light Crude

Volatility (21-Day) above 1.0% on the S&P 500 is flashing an amber warning. Breakout above 2940 is likely and would signal another test of 3000. But expect stubborn resistance at our 3000 target level.

S&P 500 Volatility

Bearish divergence (13-Trend Index) on the Nasdaq 100 warns of secondary selling pressure. Breach of 7400 would warn of a test of primary support at 7000.

Nasdaq 100

Robert Shiller maintains that Donald Trump is unlikely to survive a recession:

“So far, with his flashy lifestyle, the US president has been a resounding inspiration to many consumers and investors. But his personal narrative is unlikely to survive an economic downturn….the end of confidence in Trump’s narrative is likely to be associated with a recession.

During a recession, people pull back and reassess their views. Consumers spend less, avoiding purchases that can be postponed: a new car, home renovations, and expensive vacations. Businesses spend less on new factories and equipment, and put off hiring. They don’t have to explain their ultimate reasons for doing this. Their gut feelings and emotions can be enough.”

I would go further and argue that Trump’s management style is likely to cause a recession.

Some of the aims the President is attempting, like addressing China’s unfair trade practices, are vitally important to long-term US interests and he should be given credit for tackling them. But his constant hyperbole, erratic behavior, with a constant mix of bouquets and brickbats, and on-again-off-again tactics, has elevated global uncertainty. Consumers are likely to increase savings and cut back on expenditure, while corporations may cut back on hiring and new investment, which could tip the economy into recession.

GDP growth contracted to 2.3% in the second quarter, while growth in hours worked contracted to 0.92% for the year ended July 2019, pointing to further falls in GDP growth for the third quarter.

Real GDP and Hours Worked

August employment figures are due for release next week and will either confirm or allay our fears.

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.

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Gold: Every cloud has a Silver lining

Long-term interest rates are declining after more dovish speeches from the Fed, with 10-year Treasury yields re-testing support at 2.0%. The opportunity cost of holding gold is low.

10-Year Treasury Yields

The Dollar Index is likely to weaken, testing primary support at 95. A weakening Dollar boosts demand for Gold.

Dollar Index

A big gain in Silver this week is likely to be followed by a similar move in Gold. The two precious metals tend to move in unison. Breakout above $16.00/ounce signals an advance to $17.50.

Spot Silver in USD

Gold is consolidating above short-term support at $1400 after a strong advance, indicating buying pressure. Another advance is likely, with a medium-term target of $1500/ounce.

Spot Gold in USD

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Gold buying pressure

Long-term interest rates close to zero after inflation, with 10-year Treasury yields testing support at 2.0%, means that the opportunity cost of holding gold is minimal.

10-Year Treasury Yields

A weakening Dollar Index is expected to test primary support at 95, further boosting demand for Gold.

Dollar Index

Gold found short-term support at $1400 after a strong advance, indicating buying pressure. Respect of support at $1350/$1400 would offer a medium-term target of $1500/ounce.

Spot Gold in USD

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