Conniving Oracles

We really should stop attributing self-awareness and a sense of purpose to the bond market.

Admittedly, I do it too, but only because it’s convenient when it comes to penning daily market commentary.

The bond market doesn’t exist “out there” somewhere. It can’t “tell us” anything and it never “knows” something we don’t. There’s no such thing as “the bond market” outside of the people and machines who comprise it. Rates react and respond. They don’t think and scheme. Nor are they capable of possessing knowledge.

People think, though. And people trade. And people create algorithms which trade based on schemes people devise. All of that manifests in price action, which can’t occur independently of people and the algorithms they create.

Some of you are sighing. Or rolling your eyes. This a favorite talking point of mine and I’m acutely aware of the extent to which it can be repetitive and outright annoying. But whenever yields are doing something “counterintuitive,” as they are currently, I start to wonder whether my straw man is actually a straw man. I habitually imply that market participants believe the bond market actually exists on its own, independent of humans and machines, just so I can humorously remind everyone how silly that is. That’s a straw man because I don’t really think anyone believes the bond market is a real entity with cognitive capacity.

And yet, time and again, when rates “act” in ways not seen as consistent with the macro and policy backdrop, the line starts to get blurry. People begin to lapse into language that suggests they do, at least on some level, believe rates are a thing capable of hiding something from us, namely knowledge about the future of the economy.

10-year yields fell again last week (figure below), despite another scorching CPI print, hotter-than-expected PPI, a robust retail sales report and more evidence that, on a one-year horizon anyway, consumers’ inflation expectations are still accelerating rapidly.

The explanation for this isn’t terribly difficult to discern. Deutsche Bank’s Aleksandar Kocic summed it up nicely in his latest. “Instead of a selloff, the curve (again) is reacting with a bull flattener, as if there is a policy mistake at play — a pattern that seems to be setting in recently,” he said, of the bond market’s reaction to the latest inflation data.

“The rates market is recognizing the force of the Fed, but is also expressing an opinion — accepting that a stronger inflation print is likely to make the Fed more proactive while, at the same time, possibly forcing a mistake,” Kocic continued, adding that “on one side, the market is accepting the narrative of transitory inflation, but is seeing medium-term growth as low.”

If growth does disappoint, it suggests that “any hawkish maneuver by the Fed is seen as self-defeating” given that it would “push growth even lower, making rate hikes quickly restrictive and destructive for growth,” Kocic remarked.

That’s really the whole story, and I’d quickly note that Kocic is quite possibly the deepest thinker on the sell-side. He’s easily the best writer. So, if he’s ever read my playful missives lampooning market participants for talking about stocks and bonds as though they’re as real as rocks and rivers, he surely finds such missives delightful. When he talks about rates “expressing an opinion,” it’s stylistically consistent.

As for other folks, though, I’m not so sure. For example, Bloomberg ran the following headline on Saturday: “Relentless Bond Rally Has Traders Wondering What They Missed.”

It’s impossible that traders, defined as a collective that includes all humans and algos involved in the market, “missed” something vis-à-vis the bond rally, because there couldn’t be a bond rally (or any price action at all) without traders.

The linked Bloomberg piece documents a series of recent calls by TD’s Priya Misra, whose work I quite like. In the weeks since the June FOMC, Misra and her colleagues have repeatedly noted that the rally (and bull flattening impulse) was explainable in part by positioning unwinds and other technical factors. She was, of course, correct. All price action is, by definition, explainable if only we knew what everyone and every algo was doing (or being forced to do) at any given time.

But in remarks to Bloomberg, Misra briefly lapsed into the mystical. “We can all see why technicals can move us away from fair value for some time, but if it stays there for two months, that’s when you start thinking it must be something fundamental,” she said. “It’s not just positioning because nobody is fading it. It’s a weird market.”

With apologies, it’s not a “weird market.” It’s just a market. There’s nothing amiss here, or at least not where “amiss” denotes the bond market acting on its own in purported anticipation of a subpar growth outcome that only it can currently discern.

The same linked Bloomberg piece cites a JPMorgan note called “What does the Treasury market know that we don’t?,” in which the bank suggests yields imply 0.5% growth over the next year, well below their house forecast.

Again, we’re teetering too close to the edge of insanity, where that means not acknowledging the fact that when we look at the bond market (or any other market, for that matter), we’re just looking in the mirror. The market is just a reflection of our own buying and selling and speculating.

You’ll say that’s so self-evident as to be not worth mentioning. I’ll tell you we forget it all the time. And when we do forget it, we have a tendency to scare ourselves into creating what I refer to as a “false optic.” We believe the bond market “smells a rat” (to quote another analyst note from last week), and we act accordingly, sometimes exacerbating the very same price action, which we then cite as “proof.” At no point do we indicate that we understand our own role in the whole thing.

And look, if I’m the one who’s crazy and the bond market really is capable of possessing knowledge and foresight independent of the people and machines who trade it, maybe we should abduct this shifty, conniving oracle and take it to a CIA black site. “When is the next recession coming?! And when was the last time you saw Bin Laden?!”