Hey There Income Hunter,

 

Fed hawks sent out by Jerome Powell to put a wet blanket on the market’s reaction to his FOMC speech have failed.

 

Miserably.

 

Has the Fed’s credibility been destroyed – or is the stock market just testing the central bank’s resolve? 

 

I think it may be a combination of the two. The tripe spewed by Powell’s “pawns” was tough to take.

 

For instance …

 

“The Fed has a good chance of not tanking the economy and achieving a soft landing,” according to St. Louis Fed President James Bullard.

 

That sounds nice, but the Fed is tightening into an already weak economy!

 

In fact, it has tightened faster in this cycle than at any other time in the past 40 years.

 

The market moves yesterday show how poor bond market liquidity has become, and that is the most dangerous signal for the health of the economy.

 

Today, I’ll share what bond market internals are showing and their impact on stocks.

 

Bond Market Depth

 

As you can see in the chart below, bond market liquidity has fallen to the lowest levels since March 2020.

 

There are several reasons for this, including:

 

• Investment banks are dealing with costly limits on risk-taking, which has caused them to pull back from providing liquidity.
• The Fed shift from QE to QT has removed the largest buyer in the market.
• Fed dealers who are required to bid in the auctions are not willing to provide tight bid/ask spreads in the secondary market.
• Finally, and an important one longer term, is that the large foreign players that were supporting the market in the past i.e. China and Japan have been absent.

Inflation is another reason bonds have traded with such tremendous volatility. 

 

Following the Fed tightening policy announcement, the first half of 2022 has been the worst period for bonds in history.

 

Checkout this rise in yields for 5-year Treasury notes …

 

 

A 224% rise in 5-year interest rates that haven’t even had enough time to reveal the real damage they have done to the economy.  It takes time for that type of a move to make its way through the financial system. 

 

Higher rates and a stronger dollar hurt emerging markets that rely on dollars to buy essential goods and low rates to pay off debt denominated in dollars. 

 

Corporations were able to finance their debt at very low levels for years … Now as their revenues drop their debt will need to be refinanced at higher levels, further squeezing margins. 

 

Let’s also take a look at corporate bonds and their correlation to stocks to see what internal signals we are getting there …  

 

Investment Grade Corporate ETF (LQD) versus S&P 500 Index ETF (SPY)

 

LQD is a great ETF to follow because of its correlation to SPY. Notice below how LQD rolled over prior to SPY during the past four rallies in SPY. 

 

We could be getting a similar signal right now as corporate and Treasury bond prices traded down significantly yesterday, but you need to wait for confirmation SPY may be rolling over, as well.

 

 

Bring It Home

 

The stock rally continued its move higher yesterday, and the close above the 100-day moving average must be respected. 

 

The technicals and fundamentals are just not lining up right now. The bottom line is, the Fed is tightening into a slowing economy and it wants lower stock prices and wealth destruction to help with bringing down inflation.

 

August presents a positive seasonal factor for stocks and bonds, so if you follow the macro forces now is the time to practice patience

 

Wait for confirmation of SPY rolling over because the Fed will end up getting what they want. A doubling of QT in September will probably give them the result they are looking for. 

 

Have a great day and as always  …

 

Live and Trade With Passion My Friend,

Griff