Double, double, oil in trouble, stocks burn and bonds bubble

Long end Treasuries exploded after the Fed announcement

Long end Treasuries exploded after the Fed announcement

The bond market exploded today as the FOMC pledged to remain patient on rate increases. Stock markets reacted negatively, pushing S&P 500 futures firmly below 2000. According to Bloomberg news:

The Fed acknowledge global risks, saying that it will take into account readings on “international developments” as it decides how long to keep rates low.

The Fed also dropped a clause from its December statement that the assurance of patience was consistent with a previous pledge to hold rates low for a “considerable time,” especially if “projected inflation continues to run below” the 2 percent target. The Fed has kept its main interest rate near zero since December 2008.

Yesterday we highlighted the link between volatility and volume and we got to see it in action today as the stock market accelerated it’s decline into the close. With the ECB printing money and the Fed back-tracking from its previous language about raising rates, its becoming increasingly unattractive to own anything other than a government bond. There are many economic risks, especially from Europe and China. Stocks are a risky investment in this market. The volatility of volatility remains elevated, meaning the market doesn’t trust its own perception of the economy from day to day.

Stocks slid into the close today as the market reacted to the FOMC statement

Stocks slid into the close today as the market reacted to the FOMC statement

In this environment, stocks could be buoyed by the printing of money and embark on another phase of the bubble. On the other hand, they could just as easily crash as a large leveraged bubble starts to come undone. Leverage forces positions to be unwound at a loss, and as we have stated before the expansion of the carry trade has embedded a huge amount of leverage in the system. The Yen gained against the dollar today as carry trader’s unwound bets made when the Yen was declining.

If central banks are staying dovish, however, bonds have only one place to go. The market has whole-heartedly adopted the attitude that bonds can only go up and were dancing to that tune almost immediately after the FOMC announcement. This is a dangerous complacency as the bond market bubble is the one that would truly damage the economy if it came undone.

On a related note, the price of oil continued its slide today, ensuring that we will be talking about the risk of deflation for a long time to come:

USO

Oil is providing fuel for the deflationary fire

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s