As I mentioned in yesterday's column, it is the Treasury bond market that is calling the tune for the equity markets in the U.S. now. Well, today we are seeing more evidence of that, as the Nasdaq fell in early Friday trading in concert with the bond market's selloff, which has pushed the 10-year U.S Treasury note yield up to 1.63%.
What is interesting about these selloffs is that they begin overnight, as the Treasury bond market essentially never closes. I think we are deep enough in the information society -- and that the average RM reader is sophisticated enough -- to understand after-hours trading in equities and to follow the equity futures markets before 9:30 am. So today's selloff seemed to have emanated from non-U.S. markets, just as yesterday's ECB-driven bond market bounce also started early in the morning, New York time.
That's the world we live in. The bond market is TRYING to reset rates to a new reality that -- if not totally free of Covid -- reflects a largely vaccinated population and the removal of economically devastating lockdowns. The Fed, ECB and the world's other central banks, want constant stimulus -- and low interest rates certainly are stimulative --and thus are actually, mind-bogglingly, trying to fight the bond markets. So stupid. The central banks win occasionally on a day-to-day basis, but look at a 12-month chart of U.S. Treasury note rates and you will see who is really winning.
Today's wall of worry in the bond market is driven by the upcoming expiration of special dispensations given to large banks in the U.S that allow them to exclude holdings in U.S Treasuries AND deposits at Federal Reserve banks from their total asset calculations, under the Fed's supplemental leverage regulations (SLR.) Remember that acronym. SLR has become a political football as Democrats seek to restrain big banks' ability to pay dividends and perform share repurchases (that ability has grown in the last few iterations of Fed regulatory policy) and, it would seem from recent Congressional hearings, are attempting to pressure the Fed to fully enforce SLR again.
We need a strong financial system to avoid another crash like the one we just had...in 1929! That's the problem when people in DC are allowed to meddle in financial affairs, the workings of which they either can't or won't comprehend. Higher capital requirements for banks serve to restrain growth in an economy that is attempting to recover and don't serve to prevent crashes. No amount of capital buffer could have saved Lehman Brothers (my first Street firm, but I left in 1994, don't blame me) from the idiocy of owning (directly and via derivatives) a bunch of real estate in Riverside, California. You'll notice JPMorgan (JPM) made it through just fine (as did BofA (BAC) , although less so) and even non-stupid Wall Street firms like Morgan Stanley (MS) and Goldman Sachs (GS) have prospered in the past 11.5 years.
But we can't have a run on our banks! Come on. Into this fraught atmosphere, we have the Sheriff of K Street, FOMC Chair Jerome Powell. Do you think he cares that average U.S. retail gas prices have risen 15% in the past month and 30% in the past year? Come on. He DOES care about housing prices -- whose remarkable boom has enriched the rich while hampering home-buying ability of the middle and lower classes -- but The Fed, as a body, chooses to EXCLUDE food and energy prices from their inflation calculations, not that anybody needs those two things.
So I will continue to play the short-Treasury ETFs I mentioned in my column yesterday -- like (PST) and (TBX) . While I believe today's bond market selloff might be a little premature, I believe it is directionally correct. The odds of Powell enforcing SLR and showing even the remotest sign of a backbone versus his Wall Street ex-colleagues...are remote. Interest rates SHOULD be going up because there is more demand for money in the recovering economy, and if that hurts a 10-year discounted value calculation on Tesla (TSLA) stock, then so be it, but interest rates are not going to go up because of Sheriff Jerome's actions.
The Fed is going to keep near-term rates at zero and keep buying long-term bonds. The Fed is also going to lose as the bond market continues to reset. I will enjoy this. And continue to play it via short-Treasury ETFs PST, TBX, (TTT) , (TBT) and (TBF) .