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Why The Bond Market Warning Is More Serious Than It Appears

By:

Chief Market Analyst, Stock Traders Daily

Recent headlines have pointed to the bond market and the inverted yield curve between short-term and long-term Treasury Bonds as a reason for the declines in the Stock Market.  This signals a forthcoming recession, history tells us, but this time there’s more to observe, and it is more serious.

Another force is at play, and it should be recognized along with the inverted curve. 

First, the concerns are not isolated to the bond market.  The stock market has been hit too, but investors in the stock market do not seem concerned because the market is still up YTD.  Still, these declines need to be noted.

Stock Market Declines from recent highs as of 8.28.19:

  • The S&P 500 was down 5.5% from its recent high
  • The DJIA was down 6.1% from its recent high
  • The NASDAQ 100 was down 6.1% from its recent high

The Russell 2000 was down 9.3% over the same time, too, but it is also down 17.9% from its all-time high. The Russell’s all time high was in September 2018, where the other markets saw all time highs as recently as early August 2019. The Russell has been much weaker.

Because the Russell 2000 is generally considered to be higher risk, we can conclude that higher risk assets have been shunned over the past year, and that would be accurate.  Based on this, risk-takers have adjusted their stock portfolios, but bond investors have been active ,too.

Inverted curve or not, bond yields are down.

Yields 8/28/19 vs November 2018:

  • 2-year Treasury yields 48% less
  • 10-year Treasury Yields 54% less
  • 30-year Treasury yields 43% less

Prices and yields are inversely related, so as yields fell prices have increased.  That means the demand for bonds has increased significantly over this timeframe.  That is extremely important, and it usually happens when investors perceive risk, but what’s more surprising is that this is happening as the FOMC unwinds its portfolio, too.

The FOMC was the biggest buyer of Treasuries during Stimulus, holding Trillions of dollars worth of varying maturities, until they began to unwind their holdings, which they ramped up significantly at the end of 2018.  That means they stopped reinvesting interest and the proceeds from maturing bonds.  Now they are also selling.

The amazing thing about what is happening in the bond market is that prices are skyrocketing even though the biggest holder of Treasuries is unwinding aggressively.  In fact, the FOMC may have sold everything by now; we’ll find out in September, which is when the FOMC said they may be finished unwinding.

If demand was high enough to press yields that much lower while the FOMC was selling trillions of dollars of bonds, what would have happened if they didn’t?  What’s more, what will happen to yields when they are officially done?  If the theory of supply and demand has anything to do with it, and demand remains the same and the supply dries up, yields may fall even more aggressively, and that suggests even higher perceived risks and warnings from the bond market could be forthcoming. What’s working in this Market?  Tactical Trading Strategies are working well. 

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