Notes From Underground: Return of the Bond Vigilantes?

After the performance of the 30-year yield on Friday, we must ask this question. The overall release was on the weak side as jobs created were far less than expected, even though the RATE dropped to 6.7% and average hourly earnings increased by 0.3%, higher than forecasted. The AHE are difficult to measure as it can reflect lower wage earners being left out of the job market, as well as bonuses paid out to middle- and upper-level management.

Minneapolis FED President Neel Kashkari opined that 6.7% is a misleading figure and the “TRUE unemployment rate is roughly 10%.” The initial reaction to the headline data release was a rally in the long bonds, which LASTED ALL OF FIVE MINUTES. That’s because the market started to digest the threat of an immediate passage of the next iteration of COVID RELIEF as lack of fiscal stimulus with the economy turning down would be ever more pain for a majority of the workforce (through NO FAULT OF THEIR OWN). The 30-year Treasury bonds dropped dramatically in price as did the 10-year note, sending the 2/10 and 5/30 yield curves to levels not seen in two years.

The market view is now that the worse the DATA the necessity for greater stimulus. (In other words, SELL MORTIMER SELL.) This is where the FED is going to find itself in a terrible trap. (For more on this idea, read the comment from Mike Temple on the previous blog post.) Traders and investors will become more worried about aggressive monetary policy and eve-increasing FISCAL STIMULUS driving inflation higher. The FED has “promised” it will not react to an initial thrust in headline inflation but would be prone to utilize average inflation targeting.

However, if the U.S. central bank remains RETICENT to move its QE further out in duration — targeting the LONG END of the curve — the BOND VIGILANTES will ride again by continuing to SELL THE LONGEST DURATION BECAUSE IT IS THERE THEY WON’T HAVE TO FIGHT THE FED. The LONG END WILL BE the area of least resistance. How high will the yield on the 30-YEAR BOND have to rise until the FED’S SOMA DESK BECOMES THE IMMOVABLE OBJECT? Mike Temple believes Yield Curve Control will be necessary in the first quarter of 2021. I see no reason to argue.

The YIELD on the 30-year Treasury is 1.736%, making its effective REAL YIELD ZERO. That’s a far better return than the MERE 0.426% on a 5-YEAR NOTE. But the BOND TRADERS FEAR THE FED MORE ON THE FRONT END of the curve so the vigilantes are steepening the curves and testing the central bank. The Australians and Japanese are fervent believers in YCC. Will the FED act in concert? There is a meeting next week so listen closely for any discussion about the need to extend the duration of the FED‘s asset purchase program.

The level of the 30-year is a key variable for the ALGOS as seen on Friday. Once the yields on the longer bond yields began to rise after the UNEMPLOYMENT DATA, GOLD broke and the DOLLAR rallied from its headline-making lows with other commodities selling off (with the exception of copper and platinum).

The 30-year is in the cross-hairs of the bond vigilantes and will contineu to be until either there is no fiscal stimulus package or the FED announces its intentions and/or concerns about the long end of the curve. This is just the beginning of this discussion because it is critical to several asset classes. Will housing and autos be undermined if long rates rise to generate genuine POSITIVE REAL YIELDS? The canary in the coal mine is Lael Brainard, the bank’s primary proponent for YCC as a critical tool in the FED’s TOOL BOX. Chairman Jerome Powell has shied away from referencing YCC so this will be an issue in an upcoming post.

***Something worth examining is a chart of the S&Ps/BONDS. This relationship has been a good forecaster for the past 25 years. (It caught the SPOO rally from October 2017-October 2018 and then called for a correction.) This chart closed at all-time highs on FRIDAY as the equity market remained FIRM and the BOND prices retreated as YIELDS ROSE.

What’s very telling is that money is so cheap and homeless it looks for return by chasing equities as 5-year yields are not rich enough at 0.42 % to attract investors, especially with a declining DOLLAR. The FED is going to have to decide what it wants to accomplish and what will the real costs be, especially as the BIDEN Administration is going to tackle income/wealth inequality while ZERO INTEREST RATES continue to propel asset prices ever higher. There will be no complacency for traders heading into 2021.

Hey Jerome. time for you to contact Mr. Wizard. Drizzle, drizzle drone — time for this one to come home and head back to the serenity of the private equity world.

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24 Responses to “Notes From Underground: Return of the Bond Vigilantes?”

  1. Mike Temple Says:

    Thank you for the kind words.

    Two things

    A. It is not impossible to imagine Fed hinting more strongly about YCC at its December meeting and not waiting for Q1

    B. “Nobody” seems to be pricing in the possibility that the two Georgia senate run offs go Democratic.

    No longer non-negligible. I will not opine on politics on this board.
    But, if the Senate goes Democratic, say “Hello to Havana” as Pelosi and AOC and the rest of the Squad do wonders to the budget.

    DXY has a date with destiny at much lower prices, along with soaring 10 and 30 yr yields

  2. Tamon Says:

    Interesting take. Treasury shorts are unprecedented. Do you discount that? Biden administration? Remember what Felix Unger showed us.

    • yra harris Says:

      Tamon—Hakuna Matata—it is tough to make a lot out of treasury shorts except it is a cheap hedge in a low vol market so it makes a great deal of sense.But speculating from the short side reminds me of the JGB market in the 1990’s as every macro global trader ,including myself,took a shot at the short side —the BOJ held the level and the trade became known as the widow maker—but as much as I know that I caution this —and here is where your point is well taken—Japan had genuine deflation so real yields were still a positive 11/2 %–also the YEN was not the world’s reserve currency—what did Felix show us?not sure which event.But this is why I believe 2021 going to be volatile

  3. Tamon Yamaguchi Says:

    Hi Yea, point taken. Regarding Felix Unger, I’ll always remember that he showed us to never assume anything because when you do, you make an ass of u and me. Everybody is assuming that there will be a Biden administration. I don’t expect one and I certainly wouldn’t assume one.

    • yraharris Says:

      Tamon –thanks and glad to have you in the mix .It will take awhile to rebuild our dialogue on this blog but responses have already picked up at a high level–thanks for your addition

  4. kevinwaspi Says:

    “Drisal, Drasil. Drasil, Drone. Time for dis one to come home.”
    “Ah gee Mr. Wizard, it looks like I made a mess out of things again.”
    (Indeed you did Jerome.)

    • yraharris Says:

      Professor—-I see you and I are involved with the same cartooning and lampooning—–hope you are well

  5. Asherz Says:

    Powell has to keep his foot on the pedal. As soon as he lifts it off, the markets react. He is the latest standard bearer of “Whatever it Takes”. Buy the long end? Sure if necessary. Buy equities? The BOJ owns $400 billion. The Fed will show them.
    Is there a price to pay or can we solve a debt problem with more debt? The answer is that the currency, our once sacrosanct dollar, is being lifted up on the altar of necessity. At the end, most Americans and others will be the poorer for it. Fed mandates shmandates, the markets are the bosses. Vigilantes are Riding into town. High Noon is not that far away.

  6. silverbug2155 Says:

    And When Trump gets in any thoughts?

  7. Financial Repression Authority Says:

    […] LINK HERE to the Blog Post […]

  8. The Bigman Says:

    Okay I’ll bite and be the devil’s advocate- this call for runaway inflation- I heard it and believed it in 2009 with QE1 again with QE2 I even forget what iteration of QE we’re on and still no inflation why is it different now? Capital continues to burn on the pyre of ZiRP Heard this AM SPACs raised as much this year as the insanely overpriced IPOs. Everyone assumes we are going back to pre-Covid. How? with Biden there will be increased regulation/central planning, many small businesses/jobs destroyed forever, huge public and private debt overhang in addition to the aforementioned misappropriation and destruction of capital. Oh yeah Covid is ravaging the country and economy again. There likely will be an infrastructure program but we do not seem to do well with those- remember shovel ready jobs? another trillion down the drain and I have still have potholes in my neighborhood. With Biden(actually Obama is in charge this is his third term) in charge we will get another Obama recovery. Sorry Yra but I guess I am in the Lacy Hunt/Gary Schilling camp. FWIW

    Bonus comment from someone talking about something he knows little about and should keep his mouth shut: looks to me like the 10 year just made a triple top for the year- Our only hope is that I am frequently wrong.

    • yraharris Says:

      Bigman–why are you apologizing —I have discounted that outcome but you are in very good company .As I keep saying this is the way I will trade but certainly not married to this view until I see the red of their eyes—-we are a long way from fruition on this outcome but presently the weakening dollar is providing some initial thrust but certainly not a done deal in any way shape or form,but if Brainard were to become FED Chair YCC is just a shot away and will stoke the next leg of this trade–but do not apologize for we are here for dialectic and discord ,not validation

  9. kevinwaspi Says:

    Bigman, no apology needed, but let’s examine the conundrum of “inflation”. Have you access to personal records, and if so, compare the price you pay for a pound of hamburger, a new car, health insurance, education, or even your monthly utilities, much less your property tax bill to those of ten, or even five years ago. Forget about the CPI, PPI, or the fed’s “preferred measure of inflation”, the change in the core personal consumption expenditures price index (PCE).
    Given the composition of PCE and the nonsense of “hedonic adjustment”, the official measures of inflation will likely not show inflation above 2% for the balance of my remaining lifetime. Ask someone on Social Security this trick question: “With the 1.3% cost of living increase in your monthly payment for 2021, will you receive more or fewer dollars each month?”
    Answer for most, is FEWER, after the 2.7% increase in the Medicare Part B cost. “Lies, damned lies, and statistics” comes to mind, along with a lesson taught to me by my first statistics prof:
    “Statistics are like the bikini, they show you everything but the essentials”

    • The Bigman Says:

      Kevin good to see you back on the board. I’ll continue in my role as Satan’s advocate. Using the BLS calculator ( I calculated costs from my past compared to what they would be now.

      1. Stretch jeans In 1969 (senior year in high school) Stretch Levi’s cost $5.50 which according to BLS is $39.13 One can buy Stretch Lee’s jeans at Walmart today for $27.94.
      2. Ground beef in 1969 was $0.45/lb which according to BLS is now 3.20/lb one can buy 80% lean at Walmart for $3.55
      3. Regular gas was $0.30/gallon( and when my Dad filled up on Sunday after church he got a free Sunday Tribune) according to BLS that would be $2.13 now Average in Illinois now is 2.23 and I am willing to bet that there are more taxes on that gallon now.
      4. My wife and I bought our first car in 1977 a Honda Civic for $4000 BLS calculates that as $17,159 One can buy a Kia Rio now for $15129 and I guarantee that it is a much safer car than that tiny Civic(and probably has power windows)
      5. As far as commodities go a bushel of corn in 1969 sold for $1.20 which is $8.38 in today’s money. December contract today is $4.16.(when one asks how can a farmer make a profit at that exchange recall Milo Minderbinder’s reply: Volume)

      My conclusion on albeit limited data is that the BLS estimates of inflation for these common things aren’t bad. I did not cherry pick these. They are just what came immediately to mind.

      The places where inflation to my mind is rampant are health care and higher education as well as financial assets- all of which the federal government or the Fed are heavily involved. My tuition and fees in 1969 when I entered University of Illinois were $90 for a semester. That adjusted by BLS for inflation would now be $631. From the U of I web page tuition and fees for 2020-21 are $16,682 for the year or $8.341 for a semester As a young lad I remember my pediatrician making a house call after dark. My Dad paid him $5 and a cup of coffee. That $5 today is $46 Try seeing your doctor in his or her office today for $46. There is your inflation


      • yraharris Says:

        Bigman–what about house prices and rents?

      • The Bigman Says:

        Hi Yra Housing of course depends on location. I have two examples from here in San Diego. My friend owns a 14 unit apartment building within a mile of the beach in North County. When he opened it in 2005 rents were $1700 for 2 BR which according to BLS inflator is now $2250 The actual rent today is $2650 so the inflator misses by 18%. As far as houses I can use mine as an example my house which I have owned for 30 years(which i still have a mortgage- result of sending 4 kids to college) Without getting into details the BLS underestimates the inflation adjusted cost of my home by 66% so not very good. However what I said about Health care and higher education I believe also applies to home ownership- the federal government is heavily involved by the purchasing and bundling of mortgages and mortgage tax deductions(though Trump has limited the latter but it will return in full with Biden tax plan when SALT provisions eliminated- another gift to the haves by our “progressive” friends). FWIW

      • yraharris Says:

        bigman–your info on rents and housing was what i was pursuing—-40 years ago housing was far cheaper—-

      • The Bigman Says:

        True but also remember mortgage rates in 1989 were 10.3% now these are 3%. Allows one to pay for more house and less interest. At 10.3% rate a $400,000 mortgage payment is $3600 per month. At 3% the same payment will allow an $850,000 mortgage. As far as rent goes in 2005 it took 36% of the median San Diego household income to pay the $1700 for those 2 BR apartments. Now it takes 38%. So a 2% increase in 15 years. As far as property tax, my tax payment now, inflation corrected with the BLS calculator, is exactly the same as it was in 1989.
        so my conclusion is that in areas where you see excess inflation you also find the heavy thumb of Uncle Sam on the scale. This dog will now let this bone go.

      • David Richards Says:

        Good to see that I’m not the only senior here who was an adolescent in the 60’s and remembers it well. I think you raise some interesting points and perspectives based on your thoughtful research and past personal experiences.

        One experience I might raise based on my travels from back then as a young man. Do you know how many Japanese Yen and Swiss Francs one dollar used to buy in 1969-70? Compared to today?

  10. Pierre Says:

    Speaking of inflation. Because I read this blog.
    At the beginning of the year, I allocated 10% of my 401k to commodities, this portion has made a return of >18% this year.
    Yra as far as I can tell, both your calls on the 30 year and the weaker dollar are being played out now.
    It really is nice to be able to read all the comments!

    • yraharris Says:

      Pierre –thank you for your continued support in this endeavor–glad to see it provides light and returns

  11. Guy Williams Says:

    Great stuff Yra.  Thank you as always.

  12. Pete Mulmat Says:

    Great insight Yra! So good to have your posting again.

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