After post-fed trading the markets started to come off their highs because the bond market despite the Fed’s tone was still selling off where yields continued to rise. 10yr almost breached the 3% handle, which if it takes shape will cause a lot of nervousness and ultimate selling from equity buyers. Why?
There are a couple reasons why this is more paid attention to then in recent quarters in gauging where stocks are likely to head:
- First, The bond market is used as a proxy for both investor confidence and other financial items such as mortgage rates.
- As inflation continues to creep up rates will continue to rise which in turn will cause the fed to be more aggressive when it comes to raising interest rates thus pulling away the punch bowl in stocks.
- A concern about a blowing out the deficit from the hill is causing more concern of who will pick up the slack as buyers of our debt if the Fed is in reduction mode.
- Stock buybacks are going to be more costlier thus removing another player from propping up their own stocks.
We all know (or should have a basic understanding) as interest rates continue higher this causes pressure to new homebuyers looking to purchase or homeowners looking to refinance. As we saw in this mornings report, new mortgage applications were down 6.6% from last week and have only been up less than 3% from a year ago. Why does this all matter and how can I trade it? Simple. We will start to see two main catalysts take shape:
- Homeowners will opt to take an equity line against their home over refinance because of fear of losing their existing low mortgage rate that is locked in. What they do with that money is not our concern (Bitcoin maybe) as housing prices will have to adjust lower to entice new buyers into the market. This causes collateral values to fall and consumers may opt to not spend as much as people do gauge their wealth by their home values.
- New Buyers who are being priced out of buying a home will have to shift to adjustable-rate mortgages (sound familiar?) and with the already low savings rate we have and mounting debt from credit cards to auto loans, this will further put pressure on their pocketbooks to stay current on payments after the teaser rate expires.
Where Will The Fed Be?
The Fed has been one of the largest hedge funds to starve off a financial crisis by introducing QE and flooding the market with credit. Now that we are at full employment and normalization is the name of the game they’re in a delicate position of reducing their balance sheet by selling securities and letting existing treasury’s run off (mature without reinvesting). What does this do the bond markets you may ask? It forces bond prices lower (yields higher) because they’re flooding the market with treasuries and effectively removing the punch bowl even more in equity markets. If the Fed is not looking to purchase more debt like they did who will? China!? All you need to do is Google why they won’t be eagerly stepping up as well to take the Fed’s spot.
As the 10yr breaches 3% this will introduce a host of new problems that could cause the market to stall. Borrowing costs from companies are higher which may deter them from buying back their stock like they once did to prop up the markets, consumers will see that servicing existing debt and inflationary costs are now becoming more important, and the fact current S&P dividend Yield is at 1.81% which is below the current yield of the 10yr will force many to rethink. It’s always said that once the MSM starts talking about the narrative the trade has already happened. That means once we cross 3% expect to see many outlets to question “what now for stocks?” or, “What happens to the punch bowel?” I anticipate based on today’s price action and a host of technical factors on indexes point’s us to lower prices and a retest on the lows if we breach 3%.