Hey There Income Hunter,

One of the most important rules of trading is “bonds are a predictor and stocks are a reactor of economic growth.” 

This week was a perfect example, as the bear market rally in stocks extended its rise from last week …

While bonds as measured by the US 10-year Treasury Bond tested the important 3% rate on Thursday morning and then plummeted to 2.75% yesterday. 

An 8% move in yield over two days is telling you something is rotten in the economy. Especially heading into a Fed meeting.

Today, we will look at the bond trade during the last tightening cycle and what that means going forward …

Powell’s Big 2019 Mistake

During the Fed’s last tightening cycle in 2018, Powell also took a very hawkish approach and kept raising rates as the economic numbers softened.

Notice in the chart below how the US 10-year rate began trending lower before rates reached their peak.

Stocks continued climbing, but ultimately they collapsed all at once in December of 2018 and fell 20% in a month before Powell then actually promised that he would not raise rates any further.

Sure enough the Fed went back to lowering rates and deploying QE again once COVID hit.

I think we are looking at a different scenario today, although Powell is on a similar path. What’s different this time around is that Powell also made a mistake by easing way too much as inflation began to rise.

I see this as the big reason why the Fed will be forced to stop tightening while inflation is still well above the Fed’s interest rate. 

Now let’s look at the 10 year today against the Fed rate …

Once again, it appears the 10-year yield is starting to trend lower prior to the Fed ending its tightening cycle!

Notice the potential head and shoulders topping formation, which was broken to the downside at yesterday’s close. 

Now, with the Fed meeting next week and the 2-year, 5-year and 7-year bond auctions, this could turn out to be a fake reversal, but I have a hunch that it may stick …

This would coincide with my call that the Fed will put a stop to tightening by the end of September. 

Bring It Home

The economic numbers and earnings are definitely below par … 

Now, stocks are coming off super bearish sentiment readings, plus there is a window to the middle to end of August where the seasonal pattern is positive for them. 

Also, right now stocks are looking at “bad news” as being good because Powell may send a softer tone at Wednesday’s meeting.

I would take the other side of that bet based on history. 

Powell wants to believe his legacy is in line with Paul Volker’s who did crush inflation in the 70’s…

J-Pow however, is no Paul Volker and these are very different times. 

Next week should be fun …

Have a great weekend and as always …

Live and Trade With Passion My Friend,

Griff