Control Panel: rest stop on the journey

Stocks and bond prices have been falling since early January 2022, when the markets finally took seriously the Fed’s intention to raise interest rates to battle inflation. The Fed announced that they would strive for a “neutral” interest rate which would neither stimulate nor inhibit economic growth. The Fed’s policies have been highly stimulative so the neutral rate would be significantly higher than their emergency ZIRP. In addition, the Fed will let its huge book of long-term Treasuries and mortgage bonds begin to roll off next week. The bond market has anticipated the Fed’s announced rises by shifting the entire yield curve up.

The 2-year Treasury currently yields 2.55%. This is roughly the same as the bond market’s 5-Year, 5-Year Forward Inflation Expectation Rate (2.44%). That implies that the bond market believes that the Fed will succeed in its goal to reduce inflation to around 2% and that the Fed will keep pumping so that the real yield of Treasuries will be zero. (Historically, bond investors demanded a positive real yield that was about 2.5% over inflation for the 10-year Treasury.)

Longer than 2 years, the Treasury yield curve is pretty flat with a couple of minor inversions. The fed funds rate is 0.77%. The Fed plans to raise 0.5% in June and 0.5% in July, which would bring the fed funds rate to 1.77% in August.

Current prices for Treasuries on the secondary market have the following yields. (There will be future auctions but the just-issued prices won’t be known until then.) The bond market clearly believes that the Fed will raise rates more than twice more to control inflation. However, the market thinks that inflation WILL be brought under control – or it would make no sense to accept these yields which are deeply negative based on current inflation.

3mo	1.32% -- September
6mo	1.71% -- October
9mo	2.05%
1yr	2.26%
2yr	2.65%
3yr	2.86%
5yr	2.96%
10yr	2.94%
20yr	3.34%
30yr+	3.14%

But nobody knows yet whether the Fed will raise in September, not even the Fed itself.

The next inflation report will be released next Friday. It will have a big impact on the bond and stock markets.

Since the asset markets have been in bubbles due to negative real borrowing rates, the question is whether the Fed’s journey to “neutral” rates will let the air out of the stock market bubble quickly or slowly.

Last week, the markets took a bit of a rest stop on their downward slide. Some investors plaintively asked if it was a bottom. NASDAQ Bullish Percent bounced up to 75%, showing that badly spanked NAZ growth investors spring up in hope at the slightest whiff of improvement.

The Fear & Greed Index improved from Extreme Fear to Fear. The risk panel showed risk-on trades as the SPX and junk bonds improved relative to the 10YT. The USD stabilized. Copper rose strongly relative to gold due to the loosening of Chinese Covid restrictions. Oil and natgas are still rising strongly.

Hiring continued its rising trend while job openings decreased.

The May Manufacturing PMI® showed that economic growth is continuing in a demand-driven, supply-constrained environment. In May, the Services PMI® fell relative to April though it was still showing growth. Prices fell slightly from April’s all-time high but inflationary pressures continue.

These are strong reports that will encourage the Fed to raise interest rates to slow the economy and reduce inflation.

The METAR for next week is partly sunny and stable from Monday-Thursday. All bets are off for Friday, pending the inflation report.



The 20-year anomaly has been bothering me for a couple of months. At first I chalked it up to the fact that much fewer 20-years are issued than 10s or 30s, but later realized that that makes no sense at all … because every 30-year becomes a 20-year after 10 years, so there is no “shortage” of supply.

Any ideas?