Hey There Income Hunter,

We are beginning to witness wild swings in government bonds on a scale we have not seen in decades. 

The Fed has lost control of the bond market. This is having a dramatic impact on banks and all bond markets that are critical to an orderly functioning of the global financial system.

This month, the CME futures exchange had to briefly halt trading in some US interest rate futures.

Then on March 17 there was an interruption in trading of short-dated German bond futures.

Today, we’ll dive into the impact the historic increase in bond volatility is having on all markets and how to position for it. 

Ominous Vol Spike

The two-year Treasury note has always been the benchmark interest rate aligned with Fed policy. 

As you can see in the chart below, volatility recently spiked to levels not seen since the 2008 financial crisis. 

We are talking about three standard deviation moves during several days this month.

What impact can this have on other markets?

Let’s take a look …

More Supply Less Demand Is Never a Good Thing

The crazy thing is the incredible spike in volatility is happening when US issuance of net new Treasury bonds is on hold due to debt ceiling restrictions that won’t be resolved until Q3. 

So, supply will be increasing dramatically later this year. Now check out the chart below showing the demand side.

The first red circle shows a tiny dip of foreign selling of US bonds in 2019, which contributed to a freezing of short-term funding for banks. 

This then caused a spike in funding rates (repo) to 10% and forced the Fed to deploy QE and buy bonds onto its balance sheet.

The second red circle shows a much larger $450 billion of foreign UST selling that contributed to the worst UST market in 70 years.

The critical insight for traders to understand is this …

Foreigners are long $7.3 trillion in US Treasury bonds but all we hear is that they don’t have enough US dollars for trading essential goods.

But that is not correct 

The truth is they are NOT short US Dollars; they can sell up to $7.3 trillion in USTs to get all the dollars they need.

Imagine a scenario where foreigners who do, in fact, need US dollars are forced to sell their Treasury holdings. Where would bond volatility spike to then? 

The chart below shows the rise in issuance vs foreign demand. On the supply side, remember once the debt ceiling is lifted, which will probably be about the time recession hits, supply will soar …

What’s the Trade?

As I have been saying for months, ultimately the government will have no choice but to deploy yield curve control (YCC) as FDR did in the 1940s.

YCC is simply QE on steroids and the market impact will be enormous as inflation doubles.

Most investors will want to sell their bonds and move into commodities, real estate, precious metals and bitcoin … This is the trade I am most focused on the most.

I am also taking advantage of the high volatility that exists in stocks by selling out-of-the-money vertical option spreads.

These credit spreads provide income that can then be applied to the longer-term low risk/very high reward trades discussed above.

The best thing we can do is build generational wealth by taking advantage of the Fed’s mistakes.

Live and Trade With Passion My Friend …

Griff