Bond Yields Won’t Stop Until Stocks Get Slammed Or The Fed Adjusts

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The golden rule of technical traders is simple: Price is King. There’s nothing more important in trading than where something has already traded. Is price rising, falling, gaining or losing momentum, range-bound, breaking out or breaking down? You may have a fundamental view of what you think something should do, but until price goes your way, it’s nothing but a hunch. Rule #1 of technical analysis: don’t fight the trend. Objects in motion tend to stay that way.

Let’s say a stock is in an uptrend coming into an earnings report that you think will be bad and cause the trend to reverse. If you think the report is bad but the trend keeps going, you really only have two options: rethink your thesis, or call the market irrational.

Lately there’s been a lot of people effectively calling the market irrational. This group, which I would say comprise a decent majority of participants I know, believe the climb in yields does not align with the Federal Reserve’s commitment to not hike rates under Average Inflation Targeting. For some reason they think that the Fed reinforcing this new policy will put the long end of the bond market at ease. It’s the opposite. The further Powell commits to AIT, the less reason there is to own long bonds.

Anyone who disagrees is not respecting the technical price action. Yields have been steadily climbing since the moment it became clear AIT would be the Fed’s new policy. Look at that gap up the first week of August in the 10-year yield, between Aug. 10 and 11th. The news around that time was failure by politicians to agree on stimulus, and bankruptcies piling up as the virus spread. Not exactly an environment for a yield spike. But there was one headline that mattered: “Fed Study Says Average Inflation May Be Better Way to Reach Goal.” Go look it up! On Aug. 10th, the Federal Reserve Bank of San Francisco released a study hinting to the market that average inflation targeting would be the new policy.

Yields gapped up the next day and haven’t stopped since. The move has escalated as the Fed digs in. It’s right here in plain sight, folks. Yields don’t stop climbing in this regime unless the economy rolls over, the stock market gets slammed, or Powell adjusts his policy. If the economy is about to roar than he’s not going to change his plans unless the stock market tightens the economy through a major sustaining selloff. So if your bull case on stocks, crypto, or whatever else, rests on the Fed doing more – well, the only way you get more from the Fed is if those assets go down! So your bull case is effectively that prices go down enough to get saved? Yikes.

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Buying things because the Fed will support the market doesn’t have to have been a good reason to buy stocks for it to be a reason now for stocks to go down when the narrative is no longer compelling. Traders and investors of this generation are not used to not having the Fed as a catalyst for higher bond and stock prices. The Fed’s been increasing QE for much of the past decade, and Powell made it worse when he cut rates without a strong economic reason to in 2018, sending stocks on a two year-long rally that had nothing to do with earnings growth. It should be expected that leaving such a regime is going to be a shock.

The question for stocks is how long it will take for a better bullish story to develop. The clear one right now is the economic rebound, but so far that’s been pretty bad for expensive tech companies. There are plenty of reasons to think tech stocks can do well in an economic boom, but right now they look a bit fragile. Look at semiconductors, which are the most cyclical tech out there. Despite gains in Micron, Western Digital WDC , and other more commoditized players, the group is trading more aligned with growth companies because Nvidia NVDA and AMD got so expensive. It appears we need a wiping clean of the froth before we can buy things based on fundamentals.

As far as bonds go, don’t fight the trend. Momentum is building in this latest leg since the breakout past 1%, but the trend has been building from the moment the Fed unveiled its plan. Thinking things will suddenly turn around without a new impulse is trying to deny the price action, and that’s dangerous. Price is King.