From the Desk of Ian Culley @IanCulley
Here’s what happened last week...
A few bad actors used open profits from highly leveraged positions to purchase other assets.
When those highly leveraged positions turned against them – ripping their faces off – margin calls went unanswered, leading to a lack of liquidity.
Bonds ripped, stocks dipped, and credit spreads blew out.
Now that the dust is settling, let’s review a few takeaways from last week’s volatility and consider what may lie ahead.
Credit Spreads Had it Right
Bonds hinted at a stock market correction months ago as widening credit spreads failed to confirm new all-time highs.
The increasing stress on credit markets culminated in the High-Yield $HYG versus US Treasuries $IEI ratio blowing out to its lowest 14-day RSI reading since September 2008:
I doubt the market is heading toward a GFC-esque selloff, but the comparison provides context: The phones rang as liquidity ran dry.
Funds holding excessive long USD/JPY positions to fund other asset purchases likely imploded last week.
Credit spreads are now contracting following the initial shock. And they should continue to contract, as extreme momentum readings often lead to mean-reverting action.
Structural Trend Reversal Lacks Confirmation
Bonds might be back, but a shift in the structural downtrend is up in the air.
I noted that the T-bond ETF $TLT showed early signs of a bullish reversal at the beginning of the month (a trendline break and rising long-term moving average):
TLT continues to hold above a multi-year downtrend line and an upward-sloping 200-day moving average, but momentum has yet to confirm a bullish reversal.
The 14-week RSI must break free from a bearish momentum regime before we can add conviction to the long bond trade over extended time frames.
If we zoom out, 30-year T-bond futures are still trading within a structural downtrend:
A four-year downtrend line remains intact despite the most significant one-week rate of change since March 2020.
The recent initiation thrust may lead US Treasuries to a sustained rally. But structural trend reversals take time, especially following historic selloffs.
Meanwhile, bond bulls contend with selling pressure at logical resistance levels…
US Treasuries Hit Our Initial Targets
No matter where you look across the curve, overhead supply looms large.
The 30-year T-bond is finding resistance at its December 2023 peak:
The 10-year T-note is slipping below a shelf of former highs after hitting our initial target:
The 5-year T-note is turning lower at a logical supply zone following fresh 52-week highs:
And the 2-year T-note is running into stiff selling pressure at a critical polarity zone marked by the June 2022 pivot lows and last year’s highs:
The tactical bond trade worked. Now, it’s time to move on to the next play.
Plus, last week's explosive rally warrants a period of digestion.
I expect treasuries to correct through price until the Fed makes a decisive move.
Rate Cut Expectations Flip-Flop
Perhaps the increased probability of a 50bps point cut ignited the liquidity shock and subsequent bond rally.
Check out the target rate probabilities based on the Fed Fund futures as of last Wednesday evening:
Inventors pegged the probability of a double cut at the September meeting at 73.5% (two days removed from the VIX 65 print).
But by Friday’s close, the probability shifted toward a fifty-fifty chance between 25 and 50bps:
Investors have the jitters as uncertainty reigns supreme.
Economic data releases and FOMC comments will likely produce knee-jerk reactions in the coming months. And the VIX will rise and fall with rumors heard on the street.
Ignore the noise.
The bond market is speaking.
It’s telling us to manage risk, take profits at our targets, and pay attention to credit spreads.
Are you listening?
Countdown to FOMC
The market is pricing in four rate cuts by yearend, with the first 25-basis-point cut scheduled for the September meeting (seven weeks before the US presidential election).
Here are the target rate probabilities based on fed funds futures:
Click the table to enlarge the view.
This data is from the CME FedWatch Tool as of August 9, 2024.
Thanks for reading.
As always, be sure to download this week’s Bond Report!
