Bond ghouls invade Wall Street, putting Mr Market in a bad mood
WASHINGTON. It seems that after a long absence, the bond ghouls have arrived in force, unnerving Mr Market Wednesday morning after an initially promising trading start. Oddly, Mr Market started out in a pretty good mood at this morning’s opening bell. All three major averages were in the green early on, although only the Dow forged ahead into higher territory. But as the morning wore on, the selling started.
Now, as of a few minutes past the noon hour, ET, all three averages are sustaining an increasingly harsh beating. The tech-heavy NASDAQ is off over a percent, while the Dow and the S&P 500 are racing to catch up on the downside as well. They’re getting close.
That’s frankly disappointing, after most stocks experienced a relatively placid Tuesday. But again, it was the arrival of those bond ghouls that spooked traders, investors and high-speed machines out of their earlier bullishness.
What has attracted those bond ghouls?
Over the last few days, we’ve been hearing about the dreaded inverted yield curve in US treasury issues. That’s a move that almost always signals that a recession is on its way, anywhere from 3 months to a year after the inversion shows up. Which is why, after sending in an early scouting team last week to stir the pot, the bond ghouls have come out in force today. They’re here to drive treasurys up in price and down in yield, with an emphasis dumping shorter maturities.
Normally, yields are lowest for short-term bonds and higher as you go up the ladder to 5-, 10-, and 30-year maturities. Makes sense. That’s because when your money is at risk for a longer period of time, you’ll want the bond issuer – in this case, the US Treasury – to give you a higher rate of interest on your money. That compensates for the time risk.
But when a yield “inversion” happens, one or more shorter-term instruments start offering notably higher interest rates than some of the longer-term stuff. That seems to make no sense. Unless you’re a bond trader.
To a bond trader – or a bond ghoul (or vigilante) – inversion tells you we’re headed for a recession. It says interest rates have already peaked. Which means the ghouls think the Fed will next have to cut rates, not increase them. So the ghouls start buying the dickens out of the longer-term stuff. They want to lock in current high interest rates for a longer period of time before rates are forced head down by the recession you they think is coming.
How does Mr Market interpret a yield curve inversion?
If the yield curve inversion environment endures for more than just a bit of time (which it’s looking like it’s about to do), the bond ghouls show up and make matters worse. They bid those longer term bonds up, up and up, driving their yields down.
How are we doing right now? CNBC offers a good synopsis.
“The benchmark 10-year rate traded at 2.365 percent and hit its lowest level since late 2017. Investors are keeping an eye on rates after the 10-year fell below the 3-month rate last week for the first time since 2007.It is a development that investors call an inverted yield curve and is seen as an early indicator of a recession.
“The U.S. Treasury yield curve has inverted before each recession in the past 50 years and has only offered a false signal just once in that time, according to data from Reuters.
“‘All eyes are going to be on the Treasury market,’ said Michael Reynolds, investment strategy officer at Glenmede. ‘We are seeing a rising probability of recession in recognition of these rising risks, but we’re not blowing off the top just yet.’”
Bold type is by CDN, emphasizing the facts traders and investors are trying to digest today.
So when’s the recession going to start?
Of course, when the red recession flag goes up the flagpole, whether it’s fake news or not, the sellers come out on the stock side of the market. They tend to hit everything, but usually hit the financials and sometimes the tech stocks pretty hard.—
That’s what they’re doing today. But the selling is also gang tackling most other groups out there as well. The only good thing about this is that the selling doesn’t seem to have much volume going along with it. When you get upside or downside moves in the stock market that’s one thing.
But if the trading volume is low, it’s easier to ignore the move. It’s kind of like a head-fake. But if trading volume is high, it’s time to be alert. If the bullish move happens on high volume, that creates upside momentum, and traders will want to buy into it, which then sends prices even higher. The opposite is true of a bearish market move on high volume. Traders suddenly find they are afraid – VERY afraid – and start dumping positions so they don’t get drowned by the selling tsunami they see coming.
In reality, stocks don’t always behave this way, so you can get caught making a wrong move. But in general, if stocks are making a convincing move up or down in most if not all sectors, and if that move occurs on high volume, then any trader or investor had best pay attention.
How do we interpret today’s bearish market turn?
Today’s move is nasty, and could get nastier. But we’d be more nervous if we saw more volume. At this point, all we’d need is another rumor of a new deal with China, and the bond ghouls who started all the current fear and loathing would turn tail and run. As they do so, Mr Market could suddenly get very happy again.
But the longer we keep reading gloomy economic prognostications, the more likely everyone is to believe them and help impose a bearish mood on Mr Market. Like we’re seeing today.
We’ll see how it goes.
— Headline image: Looks like the bond ghouls have invaded Mr Market, leaving destruction in their path.
Image via Pixabay.com is in the public domain.