Bonds send a twisted message: The Fed’s rate-hike ability is very limited, and there is no mystery to this week’s Nasdaq hike. – Explica .co – Explica

We have already commented these days that the rise in bonds in recent weeks was due to very complex causes. As reactions to the problems in the liquidity markets, where there is a lot of excess, due to rotations of the large pension funds, because the FED buys more bonds than are issued in recent months.

All of this is clear to us. They are not giving the vouchers correct information.

But in the last 48 hours the bonds have carried out another reaction that in this case sends us very valuable information and that most investors are ignoring.

aplanamiento curvasBloomberg

The important reaction I am referring to is the sharp flattening of the yield curve after seeing the new attitude of the market. This violent phenomenon cannot go unnoticed.

And to understand what the bonds are telling us, the first thing we have to define is that it is the neutral interest rate in an economy. A few years ago El Economista defined it in a simple and easy to understand way:

This is the nickname for the short-term interest rate adjusted for inflation, which agrees with the use of all economic resources, keeping prices within the central bank’s 2% target. A monetary policy that neither slows nor stimulates economic activity. The calculation of this figure varies according to estimates and factors, so this rate remains a somewhat abstract concept.

As well. According to a Deutsche BanK paper, the message that the bonds send us with this flattening is that the bonds, despite what the FED says or precisely because of it, are becoming very negative on the neutral rate. In short, they see a possibility of an interest rate hike, quite the opposite of what might seem at first glance, very limited, before the FED broke the economic equilibrium.

See what Deutsche Bank says.

The market has undergone a notable flattening turn in the last 48 hours. This is extremely unusual given that the Fed hasn’t even started to raise rates. Market prices for the hikes in 2023 and 2024 have risen, but returns beyond that have fallen (Chart 3). This has also coincided with a notable drop in inflation expectations; in fact, we noted yesterday that the Federal Reserve has shown a hawk pivot even before the market breakeven points have reached their normal pre-2014 range. What all of the above tells us is that the market is taking an extremely pessimistic about real neutral rates, or *. If the Fed decides to get ahead, the market is saying it won’t be able to go very far

This type is also called r * and appears in the famous Taylor formula:

r = r * + [ 0.5 · (PIBe – PIBt) + 0.5 · (ie – it) ]

Where:

r = target interest rate

r * = neutral interest rate (normally 2%)

GDPe = expected GDP

GDPt = Long-term GDP trend

ie = expected inflation rate

it = neutral inflation rate (normally 2%)

Source Economipedia.

Well, that r * or neutral type, where the economy works perfectly, is going down at full speed for the traders in bonds, who are the finest analyzing because here there are no robinhoods making science fiction movies, this is a market with strong hands .

Two more very valuable quotes from Deutsche Bank’s work. And be careful because in the first one he gives us the explanation of something that I myself commented in the video of the 4 keys of the week and in the closing video of Friday, as I did not understand: the rise in technology. See, it’s really interesting:

In other words, a low global r * (remember that the rest of the world continues to have huge current account surpluses, or excess savings) makes the US r * lower as well. Second, a low r * is consistent with continued resilience in equities, especially in growth stocks that are heavily reliant on a low medium-term discount rate. The fact that yesterday’s equity rally was led by a huge relative turnover from Russell to NASDAQ should come as no surprise. This is the price of secular stagnation 2010-19, version 2.

One-day price action is not trending, but the market is sending out some peculiar signals that need to be monitored. In recent weeks we have insisted that the transition from the V-shaped part of the recovery to the new post-COVID steady state will start to raise all sorts of uncomfortable questions, such as the structural damage that COVID has left in rates of private sector savings, as well as the new level of equilibrium real rates. Historical evidence has shown a huge negative impact of pandemics on r *, for example. For a big dollar bull cycle to occur, the Fed has to be able to go very far. The market is not so sure.

Very very interesting. We could summarize everything, in that the bonds send us a message. They do not believe that the FED has the ability to raise interest rates much, if they can. And when they talk about bonds, you have to listen, at the moment they have a track record of 100% correct answers, when, for example, after an investment of curves after a few months recessions always appear in the US. Now the curves tell us not to believe anything of major rate hikes:

Then the bonds go up

Then those who depend on the types as the technology go up

And the dollar does not seem to have much future in its rise.

We will follow this topic closely.

If you want to go deeper into this exciting topic, I recommend that you read this article from Zerohedge.com

https://www.zerohedge.com/markets/powell-just-made-huge-error-what-markets-shocking-response-means-feds-endgame

In the article they are very harsh and warn that the Fed could be about to make a mistake that it has already made and documented very well at the time. See this quote:

As we concluded then, ‘this is the major policy error scenario because even a very shallow path of rate hikes could drive the real funds rate well above the short-term equilibrium real rate, further depressing demand. So it is plausible that the economy would enter in recession, and the Fed would quickly be forced to abort the rally cycle. As an aside, such a policy error could be reinforced by causing structural damage that puts additional downward pressure on the equilibrium real rate. In this case, the rate would flatten significantly, at least until the Fed actually reversed course by cutting rates.

Or this one:

And in a repeat of the cycle hikes aborted from 2015-2019, while market prices for increases in 2023 and 2024 have risen, returns beyond that have fallen

They also cite in the article, the paper that we talked about before the Deutsche Bank.

As if to start thinking … the situation is much more complex than it seems.

R * take note of this symbol, we can name it a lot in the future. Diabolical situation that the FED has ahead, a debt of twenty pairs of noses that also influences which type is the neutral for the economy, high inflation and the hands very tied to take action. We’ll see what comes out of all this. Houston, we have a problem!