I just came across an internal Fed staff document that shows what a mess their minds are. When you see how seriously they are misunderstanding this economy and the causes of inflation and how they are going to fight that inflation like Don Quixote jousting at windmills, you’ll realize there is no way they find a path of out of this that they are not going to make worse for us all.
Have a look at the following graph and see which of the two lines you think is going to move to catch up or down to the other: (The bonds line on the graph is inverted because bond prices run opposite of yields. So, by graphing yields inverted, you track what’s happening in bond prices. As yields rise, the price/value of bonds falls.)
The price-to earnings ratio of the S&P has tracked very closely with 10-yr-bond action for years. Every time the P/E ratio (a measure of value by comparing the price of a stock to its earnings) rose, the value of bonds rose. In almost all cases, the P/E ratio followed right after the move in bonds. You’ll see, in 2021, where bonds fell behind the move of the S&P, but that was because the Fed had seized total control on the bond market and was choosing to push bond yields down (prices up) as hard as it could with massive QE, while the value of stocks was falling in the face of rapidly rising inflation, which was being pressured higher by all the Fed’s QE. Now that the Fed is tightening faster and bond prices are plummeting in response faster than stocks are falling, guess which is going to catch up?
Let me make that easy: Bonds are almost always the smart money compared to stocks. Anyone familiar with both markets knows that. It’s practically a mantra among market gurus. The time it wasn’t true was back when the Fed totally owned the bond market as the biggest whale in the pool, sucking up half of all new treasury issuances. Everyone in the market also knows that anyone who buys half the market on a daily basis for months on end owns the market (as you’ve heard me say if you are a regular reader here, but as I briefly am explaining for those who are new). They ARE the price-setter.
That means the Fed, by intention, set bond yields/prices WHEREVER IT WANTED THEM. That was the whole intention — to stimulate the economy by bringing credit costs (yields) down. So, the Fed drove yields to the lowest levels ever (highest point for prices). And, of course, anyone doing that is going to spread those purchases in whatever manner across the full spectrum of bond maturity dates that they need to in order to maintain the kind of orderly yield curve they want (total YIELD-CURVE CONTROL).
One last review on how that works: The Fed likes a nice curve, meaning yields on short-term Treasuries are lowest; and yields over longer terms, curve upward on a graph in order to compensate for the risks of longer, therefore, more unknown, timeframes. The curve, however, inverts as it has now to the opposite shape when the present timeframe looks TERRIBLE, so safer bets look further down the road when hopefully things settle down.
If a nice curve is what the Fed wants, why would it not control how that curve looks in order to present a stable-looking economy? We all KNOW it would if it is buying enough bonds to do so. You would buy bonds in sufficient number at each maturity point along the graph to set the yield where you want it relative to shorter and longer term yields. So, we all KNOW the Fed practiced total yield curve control during its QE period, whether it declared it was doing so or not.
That brings us to today. The bond market has been freed of that Fed nonsense to go back to true price discovery in the market place because the Fed has exited the buyer’s pool, except the Fed dumping bonds is also affecting prices in the opposite manner. They seem less concerned about controlling the curve now though, perhaps because that’s a harder battle since things tend to become more disorderly on the way down and inflation is is persistent, I think the Fed has given up on managing the curve to look nice and is just doing whatever is most effective to combat inflation now, which means higher interest right now on the short end of the curve to tighten the economy as much up front as possible.
The bond vigilantes are also back, and they are going to set prices wherever they feel they need to be, not as a scheme but as simply how the MARKET works to the extent true price discovery is allowed. Right now, with the Fed forced to raise its own minimum interest rates between banks (the Fed Funds Rate) to drive short-term credit costs higher in order to tighten up the inflation battle until it gets searing inflation back down to something near its target, the bond market is also going to naturally price that in, staying ahead of Fed rates. So, of course, bonds are pricing down to compensate for inflation that they will be losing out to over time.
Inflation is still way above the Fed’s goal and, at very best, topping out but not really falling:
So, that’s half your answer to my initial question: There is NO way that bonds are going to move toward stocks. There are too many factors pressing them down. We saw that become very disorderly in a hurry in the UK where the Bank of England had to rush in to the rescue, or the whole market was about to collapse and yields soared so that prices plummeted. That same kind of pressure is building here.
ON THE OTHER HAND, there is absolutely nothing to save stocks right now from falling further and catching down to the “greater wisdom” of the “smart money” in falling bonds. I mean, realistically, what would it be? The Fed can’t come to the rescue as it’s done so many times without throwing gasoline on the fires of inflation by going back to QE. It’s at war. The federal government cannot come to the rescue if the Fed doesn’t go back to money printing, as it did in joining the Fed to save the market during the lockdowns in 2020 because the cost of its debt will soar even worse and because its at war … sort of.
Not only is the US government helping the Ukrainians fight a war to retain their independence at great cost that will require even more US debt, especially as we go to replace all that equipment getting blown up, but the US government’s existing mountains of debt are soaring in interest costs because of the Fed’s moves, so how will the government take on more debt to stimulate the economy as it did in massive ways under Trump in 2020, which continued under Biden in 2021?
Labor isn’t coming back. It died or is sick, as fully covered here and here and here; so I won’t explain that again. Productivity hasn’t gone anywhere in years, and may be now starting to rise, but it has a long way to go to make up for the greatly decreased supply of labor. So, lack of labor means continued low production for months to come.
That means GDP isn’t going to boost stocks — if it is reported honestly. How can you produce more with fewer workers and shortage of materials and higher prices. Not likely.
