Bond market will be back and the Central Banks are worried

Local market started positive on AUDUSD bounce before fading as banks rolled over with global trend after ECB confirmed that they would ratchet up QE buying in the short term to control yield climb in recent times. Tech and Resources were the best while Banks and Staples were the laggards. ECB followed the RBA trend and delivered a short term fix before the US Fed and BOJ updates next week. ECB has been reluctant to move as most of the major EU economies are in lockdown restrictions. Everyone was always expecting that they would ramp up QE buying in Q2 to help the recovery process and that is pretty much what they said overnight. No extra QE and nothing really special but more predictable politically savvy and lazy solution being repeated. At some point Central Banks have to realize that stealing from future growth and the returns of savers and retirees to bailout zombie businesses has not worked and is making the structural problems like inequality even worse. The problem with the current cycle that makes it different to the rest is that we have exhausted every avenue to prolong the reality of the economic down cycle. We are now stuck stealing from one part of the economy to keep the other part of the economy from blowing up. The segment with the biggest donors and the most lobby groups gets the bailout while the middle to low income will continue to lose services and be taxed more for decades to come.

The charts show that US is leading the world into the reflation trade due to economic miss management in the last 3-4 years that turned a synchronized global economic recovery cycle into a global recession cycle…that was before the pandemic…yes…we were heading into a recession in most western economies before the pandemic. The second chart shows clearly the correlation between US inflation surprise and US bond yield over the last 20 years. US Fed has been fudging or manipulating bond yields through that cycle but it’s has now moved to another level of “fake it till you make it” strategy. Despite these extreme moves, it is clear that the bond market is playing catch up and will require even more balance sheet expansion to hold back the cycle. If the cycle was allowed to rebalance without US Fed manipulation, the US 10 year bond yields are likely to track towards 3-4%. That will be a bus crash in most markets and no asset class will be safe in that cycle. It is logical to assume that vested interest groups are going to force the Central Banks to bail them out. Every new bailout cycle is suffering from diminishing marginal return. US has now moved to sending checks directly to the public as an admission of capitalism failing. Everyone knows that the next few quarters will deliver massive economic growth numbers as it is coming off a low base. It is easy to deliver massive growth numbers when you are running massive debt cycle. If you look at the real growth (i.e. growth in GDP after deducting handouts), the reality of the cycle is clearly negative. The problem is the growth after the pandemic bounce is flagging stagflation as we have already used that future growth to bailout current failures.

Bond market will be back and the Central Banks are worried. Lack of capex, decades of deficits, decades of massive bond issuance, currency debasement and weak growth outlook is going to keep putting Bond market against Central Banks. There are a number of macro indicators that are flagging elevated risk and it looks inevitable that Central Banks have to step up. What is the Central Bank threshold that breaks the alternative fact bubble and force them to act? Bond market will keep pushing till it find out. The cycle is coming and it can smell fear. Time will tell how it plays out.

Comments on US market last close

US market had a positive day with ECB planning buy more bonds via existing QE and White House signing off on stimulus. Both were expected but market jumps on any good news now due to leverage in the system. ECB is doing exactly what RBA did and will have minimal effect without US Fed joining the party. We will hear from them next week and so far they have been pitching wait and see. Job data was a tick better but still years away from pre pandemic levels. DOW faded half the morning pop while S&P faded a third of it. NASDAQ and RUSSELL popped hard and held despite bond yields recovering higher through the day. USD lower and commodities higher. Israel attacked Iran oil supply to Syria. US is doing more bond issuance into dicey market. Logic suggests ECB following RBA may be the plan for US Fed and BOJ next week. Good for gold as real yields collapse. Banks, Utilities and Staples were worst while Tech and Gold were the best. Expect volatility to remain high through March.

Remain nimble, contrarian and cautiously pragmatic with elevated global macro risks!!! Buckle up...it’s going to get bumpy!!!

Full SUNSET STRIP report with end of day market stats are on the attached link.

(VIEW LINK)