A Paradox

Apparently undeterred by the bond tantrum and accompanying equity jitters, investors poured a sizable $22.2 billion into stocks in the period through March 3, the latest EPFR data showed.

Perhaps “undeterred” isn’t quite accurate. The breakdown, summarized by BofA, shows “just” $6.3 billion went to US shares, with small-caps and value dominating, while large-caps and growth lagged (the latter saw a $2.5 billion outflow). That suggests a “go with it” approach to rising yields.

Still, tech inflows were $2.3 billion, suggesting some combination of dip-buying (i.e., Classical conditioning) and a refusal to abandon what’s “worked” despite tech being almost synonymous with secular growth, which is squarely in the firing line as bond yields rise.

The bank’s “Bull & Bear Indicator” was “steady” at 7.2, just shy of a sell signal. The local peak was 7.7 on February 11.

In this week’s edition of BofA’s popular “Flow Show” series, the bank’s Michael Hartnett called bonds “big, fat & trendy,” which sounds like something you might hear from an elderly couple strolling through the surf and complaining in politically incorrect terms about the throngs of inebriated spring breakers gathered like so many gulls on an overcrowded beachfront.

As is his wont, Hartnett managed to paint an exciting picture. His pen produces words, but it often “speaks” in equations too, which makes for a fun read, but an extremely challenging parse.

The “immediate outlook,” Hartnett said, “is excess fiscal stimulus + ‘boom’ data + subservient Fed + social/political desire for more inflation & less inequality.” There was more “boom” data on Friday, as February payrolls blew away estimates.

If you ask Hartnett, “the bond bear is likely not over.” The market, receiving little in the way of pushback from officials, “will now likely push the Fed” further, he said, positing 10-year US yields rising beyond 2% and possibly triggering a yield-curve control announcement, which he described as “inevitable.”

Hartnett also alluded to poor outcomes and undesirable side effects. “All historic government policies to fix asset prices end with hubris, leverage [or] abnormal valuations,” he contended.

I’m actually not sure that’s the case, and even if it is, I would note (again) that from a big-picture perspective, we (humans) simply don’t have enough history to go on when it comes to making definitive claims. The history of “governments” is even shorter. The history of governments interacting with “asset prices” shorter still. The Earth is 4.5 billion years old. If you were to plot the dawn of humanity, governments, and government tinkering with markets on that timeline, they wouldn’t even show up (they’d be squeezed so far to the right, they’d be invisible).

That may seem like a silly (or irrelevant) thing to say, but it’s not. “Assets,” where that means bonds, stocks, etc., aren’t real things. And contrary to what any analyst tells you, central banks can absolutely set their prices as long as market participants have more faith in money than the assets and the markets on which they trade.

Hartnett noted that the RBA has found yield-curve control to be a bit more difficult to manage than they perhaps planned for. That’s absolutely true (and I’ve mentioned it in these pages on multiple occasions over the past couple of weeks), but ultimately, what is an AGB? It’s just an interest-bearing Aussie. And who controls the Aussie? Exactly.

Hartnett went on to say that “the era of speculative assaults on central bank policy has begun,” which means it might be wise to “own volatility.”

He may well be right. My point here isn’t to criticize. No matter how heavy-handed their interventions, central banks are still on the same page with traders, investors, and most of humanity when it comes to the notion that markets exist and are able to “speak” and otherwise convey their feelings and preferences. Policymakers recognize their capacity to muzzle markets, but no central banker is prepared (yet, anyway) to simply come out and declare that all of this is void and that prices will be literally administered going forward.

But what’s important to understand is that to the extent bond yields move higher (or YCC points on the curve deviate from targets), it’s at least partly because traders believe central banks are willing to countenance it. This is especially true in the US, where the Fed’s capacity to dictate outcomes cannot be called into question without simultaneously asking existential questions about the dollar.

So, when you think about the backup in rates in the US, I’d argue it’s not a “speculative assault” on the Fed. In fact, it’s the opposite, something BMO’s Ian Lyngen and Ben Jeffery hinted at on Friday morning.

“For better or worse, the Fed has altered investors’ understanding of its reaction function to higher yields via a demonstrated and articulated comfort with 10-year yields above 1.50% and 30s over 2.25%,” they wrote, adding that “given the inordinate degree of control the Fed has exerted over the Treasury market during the pandemic, to attempt fading the bear steepening at this moment would be to fight the Fed.”

Think on that.