After months of talking about the reflation trade and potential inflation building in the system, and the bond market reacting by falling despite Fed QE buying, it seems now everyone has become a bond market specialist. The ticker has been added to each of one's screen and most are following it tick for tick to determine what to buy or sell. We have now come to a point where knee jerk yield trading is dragging all asset classes up or down based on their correlation, and sector allocation too. As 10 year US Bond yields touch 1.6%, the million-dollar question is what happens next? Does the Fed come in and rescue the bond collapse by buying more but via some sort of operation twist 10.0 to smoothen the curve, or reread the same old script ignoring the inflationary signs and test the bond market's wrath?
Portfolios which are long/short claiming they have alpha here, really just have one trade on. If bond yields squeeze much higher, Technology and long duration assets get sold and Energy/Financials keep getting rerated higher, thanks to OPEC now as well. Until bond yields get to a level when something snaps, and then all falls, no theme no discretion. The Fed has been reading the same script for the last three months: "We aim to provide loose monetary accommodation till we reach full employment or inflation is above our 2% target". These are mutually exclusive for the time being as at this rate inflation will certainly be above 2% considerably, but without full employment. We have to remember that the Fed has always played a reactionary role, not a pre-emptive one. They put out fires, not sit there and analyze and try to get ahead of anything. Remember 2008 when the Fed said, "We see no bubble in the housing market". They genuinely do not know, and just sitting there cranking the printing machines hoping "it all goes well". And if it doesn't, heck we will just print another $10 trillion.
For now, Cathie Woods famous ARK funds (ARKK) seems to take the view that the Fed will not let the bond market fall, and if it does lead to an equity market collapse, they will embark on yield curve control. With that assumption in mind, the ARK and the Technology sector is just one big bet on bond yields. Since 2019, ARK Next Generation Internet ETF (ARKW) is up 300%+ and in the last month it is only down 25%. Not a bad return have to say. If we think there is genuine inflation in the system, and bond yields play catch up to breakeven rates of 2.5%, then there is more downside. If yields are capped, then this sector can have another face ripping rally. It is important to remember that in the broader secular themes, we can still get 20%-30% violent moves in the opposite direction. It seems right now everyone is so bearish and hoping for the ARK funds to fail, ProShares UltraPro Short QQQ (SQQQ) has seen the largest call volume go through suggesting that everyone is loaded up on puts on Nasdaq. Sod's law?
One new factor that has emerged recently is the strength of the U.S. dollar. It is one of the biggest shorts in the market and has been the no-brainer call to be short given all the money printing. But it has stopped going down even with a $1.9 trillion fiscal stimulus bill announced. If the dollar rears its ugly head, alpha or not, even the reflation names like Energy and Commodities will get hit.
It seems March is a crucial month, and day on day portfolio and stock allocation depends on the fate of the bond market and the U.S. dollar here. Anyone claiming any edge or otherwise outside of this is clearly more delusional than the Fed.
