If there was a silver lining in an otherwise bad week for equities and risk sentiment, it was that bonds cushioned losses in balanced portfolios.

Investors learned in 2022 that you can’t take a negative stock-bond return correlation for granted. Or that if you could for two decades, you can’t anymore.

The assumption that stocks and bonds move opposite each other (or that stocks and yields move in the same direction) was regarded since ~2000 as for all intents and purposes inviolable. As a consequence, 60:40 became the bedrock for retirement planning. The same correlation assumption underpinned God only knows how many leveraged multi-asset strategies.

Alas, it blew up alongside the demise of the four-decade bond bubble. The Fed’s efforts to corral a generational inflation spike torpedoed equities just as Treasurys careened to their worst losses on record, leading to commensurately large drawdowns for balanced portfolios. In that context, it was nice to see bonds rally as stocks fell this week, even as the nature of the rates rally felt unnervingly chaotic.

As the figure shows, the most famous long-end Treasury ETF just scored its best week since the onset of the pandemic. As noted in the new Weekly, 10-year US yields fell the most since Lehman.

I think a recession’s likely, but there’s scant evidence to suggest a deep downturn’s on the cards, which to me suggests the move in rates is overdone. By the end of the week, the short-end had lost its mind entirely.  “As we watch the futures market price in more than 135bps of cuts by year-end, it’s difficult not to interpret this as an overextended move,” BMO’s US rates team gently remarked.

“Overextended” was an understatement. Fed wagers were bananas in and around payrolls. Do note: A lot of the Friday freakout was a combination of short convexity and the optics from the Sahm rule. I’ve used this quote twice already, but it really was prescient, so I’ll use it again:

Chairman Powell may not be concerned if the Sahm Rule is triggered, but markets will be. It is one thing to have lofty valuations in a ‘Goldilocks soft landing’ as the FOMC pivots towards easing. Those same lofty valuations offer no protection if the slowdown gains momentum and risks evolving into a recession.

That’s from Mike O’Rourke at JonesTrading. I featured it at the top of the Daily on the evening of August 1, which is to say just hours ahead of the jobs report.

O’Rourke was spot-on: Markets were going to trade the Sahm rule if it triggered. And they did. The figure below shows the five-day rolling change in 2024 Fed-cut wagers along with the same for two-year yields.

You don’t see that every day. That’s what Claudia hath wrought. And, again, it was doubtlessly exacerbated by systematic flows and dealer hedging.

“In fixed income, we have seen a panic grab into the front-end,” Nomura’s Charlie McElligott said. “All of the Fed re-pricing and [the] economic sentiment shift has seen a massive inflection in what had been [a] legacy tightening-cycle short in bonds and STIRS from the CTA Trend universe.”

On the bank’s estimates, CTAs’ short-covering and bond-buying across G10 rates over the course of a three-month rally for Treasurys was ~$229 billion in STIRS and a comparable tally in bonds. “The slowdown and cutting-cycle commencement has been aggressively priced,” Charlie said. 

That was 13 minutes ahead of the jobs report. A few hours later, in a second note, McElligott commented on the escalating post-payrolls rates rally. “Sure seems obvious that rate-vol desks are bearing some short gamma brunt via the oodles of receivers and calls they’re short to incessant customer demand,” he wrote.

If you have any doubts about the relevance of the triggered recession rule, look no further than the figure below.

According to (as of now incomplete) Google trends data for this week, macro watchers, traders and investors were furiously researching Claudia and her rule in recent days. Or reading stories about them. Both.

Coming full circle, at least rates and bonds were “your hedge” into the equity selloff. But, again, the rates rally felt disorderly. Panicked. Forced.

It’s probably a fool’s errand to fade it just yet, but don’t be surprised if the short-end (and rate-cut pricing) retraces a bit. The Fed isn’t going to deliver 125bps worth of cuts between now and year-end. Or if they do, something very, very bad happened.