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Why the Bond Market Is Behaving like My Cats

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Why the Bond Market Is Behaving like My Cats

Today’s bond bulls and bears are fighting like Rose and Joey

The bond market is acting like my two cats, Rose and Joey (pictured above). There are moments of calm, followed by short bouts of furious activity. They line each other up, then stare each other down. And a moment later, all heck breaks loose. They attack each other, filling the house with screams. And then, very quickly, it is over.

Fixed income investing is like that these days. Bond bulls and bears are pushing each other around. Instead of using their paws, they are using their dollars. The result is a higher level of interest rate volatility than we have seen in some time.

Bond Bears vs. Bond Bulls

Bond “bulls” believe that the Fed will lower interest rates. They believe the new rate cycle (down, after a few years of up) will start in about a month, at the Fed’s next meeting on July 30 and 31. They also believe that this will allow the U.S. economy to brush off concerns about slowing consumer spending, corporate profits and tariff wars. Instead, these rate cuts will open a new phase of the now 10-year old economic boom. Furthermore, this will push stock prices higher.

On the other hand, bond bears think differently. They allow for the likelihood of Fed rate cuts. They don’t deny that rates will head lower.

Where they differ from the bulls in the likely impact on the economy and markets. The bulls see any cut in rates as the proverbial “pushing on a string.” That is, the economy is weakening, and lowering rates will not make that better. Rates are already low, so dropping them further only serves to narrow the Fed’s wiggle room, should the economy and markets really get rough.

Rose vs. Joey: the “tail” of the tape

That explains why the Treasury Bond market has been a lot less boring than it usually is. What is rarely boring are the battles between our cats. Rose is a lightweight, self-confident 9-year old. She joined us back when our only pet was a dog named Roxy. We added Joey, a big, sweet 18-pound lump of hilarity to the family 5 years ago. After Roxy passed away a couple of years ago, the cats became a main source of pet companionship and in-home entertainment for my family.

The epic cat-fights described above are a daily ritual now. But as the summer continues, I see the same type of daily schizophrenia in the bond market. This is not normal (as it is for the cats). Rather, to me it is another sign that we are nearing a pivotal point in the market cycle for stocks and bonds.

As this chart shows, the bond bulls have been winning since the 10-year U.S. Treasury Bond’s yield started to drop last October (note that the chart legend to the right is the rate of the 10-year multiplied by 10, such that 20.00 is a yield of 2.00%. However, it could be a shallow victory, since bonds are now even less attractive as long-term investments at a 2% yield than they were at a 3% yield.

10-year rates have been on the move the past 9 months

Related: The Real Problem With Fed Rate Cuts

Powell vs. Trump: a budding rate battle?

Returning to the human side of the markets, it is possible that the Fed does not cut rates at all. Fed Chair Jerome Powell can give a big Bronx-cheer to Queens native President Trump. After all, the President has been tweeting frequently about his displeasure with Powell.

So, as famed market watcher Jim Grant said on CNBC last week, Powell could not lower, or even raise rates. The Fed could do this in the name of standing firm against any threats of inflation, and keeping rates where they are. As Grant put it, Trump probably can’t fire Powell, but Powell could fire Trump. In other words, if the market does not get its desired rate cut, that could open the doors for a long-awaited recession and bear market for stocks.

Naturally, Trump or any other U.S. President would want anything that keeps the economy growing while they are in office. Furthermore, next year is an election year. However, the Fed is independent of the White House, and is supposed to be devoutly apolitical. Therefore, it is possible that Powell plays Rose to Trump’s Joey. I am not counting on that, but it is one of those things that, as risk-management-focused investors, we must keep on the table.

Dealing with a finicky bond market

My approach to today’s fast-moving bond market is as follows:

  • Remember the big picture: rates are historically low and recession signals are abundant
  • Opportunities to profit from sharp moves in either direction will likely continue for a while
  • Rates on shorter-term bonds were at attractive levels for a while (T-bills were in the 2.50% range not long ago). However, that ship may have sailed for now, removing another equity market diversification tool.
  • Investment risk management is more important than at any time since the Great Recession over 10 years ago. Above all, keep in mind that the methods of preserving and growing capital are very fluid.
  • Complacency at times like this is only a temporary strategy. You need to think beyond today’s conditions. Like Rose and Joey, it helps to get into position before the “action” starts.
  • When the reward/risk balance changes sharply, do what my cats do when one of them decides its “go time”: attack and defend! Today’s markets will reward those who do
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