URGENT: The Bond Market JUST Flashed a MAJOR Warning

Long-term bond yields have made a pretty sizable move higher, but rather than portend some major shift in market thinking on inflation or deficits or treasury market liquidity as you so often hear, notice what's missing from the story. Okay, long-term bond yields are up, but what about short-term rates? In the treasury market, while the 10-year has gone up a fair amount, the two-year has not. And see, it's not just the treasury market though. We see the same thing in bond market after bond market, from maples to boons. And that means it's not specific to treasury securities or the treasury department. But that's what you're going to hear again. Rising long-term rates are rising because the market is rejecting the government's deficits. While that would be nice if it was true, how many times have we heard the same thing and how many times was it ever real? The answer is zero. Canadian rates are up and so are those in Germany. Neither country is in the same boat or even the planet as Uncle Sam where it comes to being broke. There has to be something else going on in global bonds besides too many treasuries for the millionth time. So what is happening in global bond markets? For one thing, curves are steepening. We can't ignore that, but really it comes down to waffles and twos. What I mean by that, well, let's start with something that I wrote back on March 28th in our deep dive analysis. What I said back then was, in the short run, wafflers and those who are bound to join them are in charge of this short-term rate uncertainty premium. I'll get to what all that means in just a second. Absent a specific catalyst such as a major miss on payrolls next week, a spike in the unemployment rate, or indeed a negative GDP print next month, the initial one for Q1, the path of least resistance moving forward for the bond market is higher at the long end and owing mainly to waffles. Well, payrolls appear to be solid. They weren't actually solid, especially when you consider the revisions, the unemployment rate holding steady around 4.2%. And while GDP did turn negative, it was immediately dismissed as an import-driven technicality. Instead, what happened was interest rates were detoured from that path of least resistance as I laid out by the deflationary outbreak in April. Now that the outbreak has moved into the past, interest rates are going back in that same direction, but only some interest rates. Notice what I said on March 28th. Long-term rates, path of least resistance is higher owing to mainly to waffles and that uncertainty. But short-term rates, very different story. So what do I mean by waffles or an uncertainty premium? Well, the Federal Reserve, like any other central bank, introduces unnecessary uncertainty with its intervention in the short end of the yield curve. They call it stimulus and tightening. What it actually is, is uncertainty, confusion, and unnecessary manipulation. But if economic weakness gets to be obvious enough, which is what I was talking about in that DDA, then there's less uncertainty about future path of short-term interest rates because, like last summer, we know the Fed will cut. So when macro evidence comes in that looks like the economy's turning in the wrong direction, we know what the Fed's going to do in response to that. But when the data isn't so unambiguous and clear, what that means is the Fed's uncertainty is going to be driven largely by its institutional bias toward inflation. Now, before we get back to the rest of today's video, I want to tell you about today's video sponsor. We talk all the time on this channel about the dangers the world is facing, trying to come to grips with the aftermath of the pandemic and the lockdowns, the difficulties associated with the supply shock and price illusion, not to mention still living in the shadow of the 2008 crisis. To put it mildly, there's a lot of systemic uncertainty. 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And now back to the rest of this video. You have to realize how strongly ingrained that bias is. And it goes all the way back to the 1970s and Arthur Burns. So this is not just a 2020s thing. If you go back into even more recent history, it's always there. In fact, 1994-1995, the rate hikes back then, those were over inflation risks that didn't exist. Greenspan saw inflation that wasn't actually at a risk at all. Same thing in 2000, the late 1990s in the dot-com bubble. Alan Greenspan seeing inflation risks that didn't exist, started raising rates in 99, on and through to 2000, almost right up until the start of the dot-com recession. Even in 2008, the 2008 oil price spike, the Fed debated that they would have to raise rates in the second half of 2008, all because oil prices were pushed higher by a supply mismatch. And even in 2008, the Fed needed Lehman and AIG, the massive meltdown to start cutting rates when it did. I'm not kidding, they paused from earlier in the year because they were worried about oil prices and the effect of oil prices on consumer psychology. They had started cutting rates in 2007, then there were massive cuts in January 2008, another big one in March when Bear Stearns failed or nearly failed, it actually did fail. And then there was one last one in May of 2008, a 25 basis point cut, that was supposed to be the last one that got it down to 2%, because the Fed didn't want to go lower into what was considered historically low territory. They were concerned. First of all, they believed that they had done enough, that the crisis had ended with Bear Stearns, but they were increasingly concerned because of that belief, that moving forward, that maybe they have lowered rates too much, and with oil prices surging, the rest of 2008 wasn't going to be deflationary in their mind, it was going to be inflationary. This wasn't just a Fed thing either, the ECB actually raised rates in July of 2008. July of 2008 because of this institutional inflation bias. So throughout 2008, as the worst deflationary monetary conditions we've seen since the Great Depression were developing, the Fed's institutional bias, the ECB's institutional bias, economics institutional bias, had everyone seeing inflation. So the bar, the standard to get policymakers and economists out of their institutional inflation bias is relatively high. That's the point I'm trying to make here. So that's what I mean by waffling. So the market will see economic fundamentals that are consistent with lower rates, lower growth and inflation expectations, bond yields want to go down. But with the Fed obsessed with these inflation risks, or as they see them, it creates uncertainty about the future path of short-term rates because the Fed manipulates the short-term rate. Therefore, the Fed is waffling back and forth between the economy's not doing well, but there's also this inflation bias. The market has no clarity on the future path of short-term rates, especially since we've seen time and time again, the 2008 a perfect example here, the Fed will sit on their inflation bias even as the economy falls apart for far longer than they otherwise need to. So that obsession with inflation risks not only creates uncertainty about the path of short-term rates, it's mainly about the timing of them. So waffling about risks, they see the downside risks to growth. In fact, more recently they've talked about them. They see the downside risks to growth and employment and they also say that they believe the impact of tariffs on consumer prices will be transitory. But while they say this, we know they aren't at all confident about it, especially after the 2021 experience with transitory prices. So every single piece of information which does indicate that tariffs are raising prices, the waffling goes up, meaning a higher uncertainty premium for especially long-term bond yields. And this week we had Canada's core CPI as well as the UK CPI to contribute more to this uncertainty premium to this waffling. So that's exactly what we've seen. Going back to March 28th and that deep dive analysis I wrote, I said the path of least resistance for long-term rates was to be higher. And so when you take out the deflationary outbreak in April, that's where long-term rates have been generally trending. We see it more clearly now that we're further away from the liquidations. The 10-year treasury, for example, back on March 27th was 4.38 percent and today it's around 4.60, 4.59. It closed yesterday at 4.59. So a pretty significant move, not a huge one, but a pretty significant noticeable move higher since the end of March. The two-year, by contrast, that was 3.97 on March 27th and today it's around 4 percent. So basically not much movement in the twos with more movement in the long end. And the reason the long end is moving higher is because, as I said, uncertainty about what the Fed's going to do in light of all this waffling over the possible inflationary impacts as the Fed sees them from tariffs. This is not, like I said in the introduction, this is not strictly a U.S. treasury phenomenon. We see this in Canada. The 10-year in Canada yesterday set its highest rate since the middle of January. At the same time, while two-year rates are moving up somewhat, the yield curve in Canada is steepening out the same way we see in U.S. treasuries. Long-term rates are going up faster than short-term rates which are more stable and steady. Same thing in Germany as well. The two-year rate in Germany, the Schatz, is down well under 2 percent. Meanwhile, the 10-year is creeping back higher to around 2.6 percent. So both curves, all three curves, are actually steepening with the two-year spot on those curves remaining relatively steady. And we've seen this before too in treasuries and not all that long ago. We just did this back in December. Same exact setup. The 10-year yield went up pretty sharply. At the same time, the two-year didn't. The curve steepened. And everybody focused on the 10-year and said the treasury market is breaking down because it's worried about deficits, it's worried about inflation, it's worried about the Fed, and it's higher for longer. Only part of that was true. So the twos had come off their September lows to around 4.3 percent by the middle of November. But after the middle of November, they were remarkably steady no matter what happened right around the 4.3 percent level all the way until middle of February when those economic fears finally started to show up more concretely and even in places like the stock market. The 10-year, by contrast, that began to rise sharply late in November but really the first week in December. It was blamed on tariffs igniting inflation. You remember the Fed's hawkish rate cut at its December meeting. Everyone said it was deficit fears plus inflation and all the other excuses, bad auctions, whatever we hear coming up even today. But no, what it was was a combination of, first of all, the waffling, the Fed going back to its inflation bias in the absence of more concrete evidence, more unambiguous evidence that the U.S. economy is indeed falling off with more problems in the labor market. So you did have Fed waffling in December. That was the hawkish rate cut. At the same time, though, we had bull steepening going on in the curve, which oftentimes does lead to a rise in longer-term rates, especially relative to short-term rates. We saw this in 2008. We've seen it in other bond curves around the world. That was completely natural. But happening when it did, it had a lot of people talking about, well, the 10-year's rising, it must be because of deficit fears and too many treasuries. There was also, remember back in December, reserve managers around the rest of the world were selling treasuries with a growing dollar shortage. And there was a pretty substantial dollar shortage as we saw all those currencies crash related to this dollar shortage that developed. While the reserve managers were selling the two-year too, there was more buying across the marketplace at the two-year spot than at the 10-year that kept the two-year rate steady. So that begs the question, why would the two-year rate be steady compared to the 10-year when this all seems to be, this waffling all seems to be about Fed policy? Isn't the two-year the most sensitive spot on the yield curve for interest rate policies from the central bank? And under normal conditions, that's the case. The two-year is sort of a blend between the long-end fundamentals, the independence of growth and inflation expectations, as well as looking at the front of the curve of what Jay Powell and the Fed might be up to. In circumstances like this though, the roles reverse. Under these conditions, the two-year tends to be more sensitive to fundamentals than even the 10s or any other long-term yields, to the point that it even sets aside any of this uncertainty over the future path of short-term rates. That's because in the short run, the two-year treasury, the two-year spot on the curve, and even shorter-term rates and shorter-term maturities, they have a huge payoff if the weakness comes to happen. Because bull steepening means more potential for short-term rates to go down compared to longer-term rates. So there's more profit potential at the short end of the curve. So as long as the bull steepening case remains possible, the market's going to love the 2s more than they're going to love the 10s. Because historically, the 10s, as I just mentioned in bull steepening, they don't perform nearly as well. Therefore, the 10s become the outlet for uncertainty rather than the 2s. So the 2s, under normal circumstances, might be more likely to price the Fed in its perceptions. Under these circumstances of bull steepening, you want to keep to the 2s and sell the 10s with uncertainty because that's where the profit potential is if the fundamentals continue to play out. The 2s are going to go down a lot more in yield, therefore up in price, whereas the 10s historically in bull steepening, they don't go down nearly as much. So the 10s become the object of uncertainty and the 2s become the market's object of fundamentals. We saw this too way back in 2023. It sounds like it's a long time, not even two years ago. But back in 2023, same thing. And I pointed out at the time, watch the 2-year, not the 10-year. The 2s had moved up from, they moved up pretty sharply from the bank crisis lows, but yet they stalled out by mid-July, right around the time we saw swap spreads begin to compress all over again. And while they did go higher, meaning the 2-year rate, it never did unvert compared to short-term Fed rates. Meanwhile, the 10s and other long-term rates were soaring, and everybody said it was deficits, it was bad auctions, it was inflation, it was higher for longer, so a high degree of waffling back then too. And as I said, focus on the 2s because those were more fundamental, while the uncertainty came out in the 10-year. So over the past week, we've had economic data come in that just feeds more of the waffling. Because we had the UK CPI that came in well above expectations, which, I mean, on inflation fears over tariffs, this seems to confirm them. Therefore, the Bank of England, which is already among the primary waffles out there, this isn't going to help with uncertainty over the future path of short-term rates from the Bank of England perspective. Same thing in the Bank of Canada and up in Canada. The Bank of Canada has been more aggressive in its rate cuts up to this point, but more recently, they've joined the Fed and the Bank of England in saying, we don't know what's going to happen with tariffs, therefore anything that comes along that seems to confirm potential inflation fears, therefore you're going to have more waffling out of Bank of Canada officials. And this week, while the headline CPI in Canada was lower than expected on a collapse of gasoline prices back in April, the core rate was above expectations, and therefore you can't, I mean, just guess which one everyone focused on, everyone including economists and policy makers. They focused on the core rate, which seemed to confirm their inflation bias, and therefore more waffling in Canada, which sent the 10-year in Canada, as I mentioned, up to its highest yield since early January. But it's not unique to Canada, it's not unique to Treasuries, it's not unique to the 10-year in Germany, the booms. Instead, we see the global bond market behaving in this way, as I wrote back in March 28th in our deep dive analysis, the path of least resistance over the short run is for longer-term rates to go up. So we need to watch the short-term rates because that's where the fundamentals are. And those fundamentals in the two-year, I mean, target, this week came out with just horrendous earnings and guidance. They said they had fewer shoppers come into their stores and fewer shoppers online too, and while the media tried to make that into some boycott, it was really about the economy. And you could see that in the data where target said, not only did they have fewer shoppers come in, the shoppers that did come in actually spent less overall when they did. That's an economic factor, not something else. We've, time and again, we've talked about the weak labor market in the United States, one that's well overstated. The revisions to the payroll reports would show conclusively what you think of the labor market today, it's not going to be that way tomorrow. I mentioned the BEDS survey, the Business Employment Dynamics Survey, or what they call now BDM. That one showed how last year, even before we get to this year, maybe the entire labor market in the U.S. had stalled out, leading eventually to the Federal Reserve cutting rates in response to that weakness the market was already dealing with, especially the two-year maturity. How about retail sales? Retail sales, while they came in well above expectations in March, that was only because of a splurge, but in the context of what we're talking about here, overstating the economy, the Census Bureau also issued benchmark revisions to retail sales that pretty substantially marked everything down by roughly two percent over the last several years, which means that as strong as you thought consumer spending was, it was actually a fair bit weaker than what everybody said at the time. Again, more consistent with the market position, pricing the fundamentals, not the uncertainty in the central bank policies. Remember what's driving this institutional bias toward inflation. It's a bad theory on the subject. Economists don't know where inflation comes from, so they've invented a couple of reasons, especially expectations theory, that inflation is somehow psychology. That's what captured Jay Powell, the Federal Reserve, the Bank of Canada, the Bank of England here. They're afraid that you and I are going to normalize, we're going to see a CPI rate that's above normal, even if it's a fake CPI rate, it's all artificial imputations, we're going to see that, we're going to alter our behavior, and therefore become the inflation that these economists are afraid of. So their institutional bias is based on bad theories. No wonder we have a higher uncertainty premium in the marketplace, and also it makes sense why that uncertainty would be channeled at longer term rates under these conditions, given how bull steepening plays out, and will play out if the fundamentals the market is pricing are true, bull steepening plays out with more potential up at the front than in the back, so uncertainty that's driven by central bankers, well up at the front of the twos, that's where we focus on for the fundamentals, and we've got more than enough corroboration that says, yeah, watch the twos. But every time there's an uptick in long-term bond yields, and we've seen this repeatedly over the last several years, there's a very loud and growing chorus that this time is different. Meanwhile, it isn't different, not where it really matters. And the two-year was a big clue back in 2023, when the deficit really was exploding in almost epic fashion, or they said inflation was going to be 1973, and the Fed was going to shoot short-term rates up into the double digits. The twos said none of that was happening. It's not different this time. Deficits, sadly, don't actually matter. What does is the anchoring in the macroeconomic and monetary fundamentals, we haven't talked about those yet, the monetary fundamentals and macroeconomic fundamentals at the two-year spot on the curve. We saw it again last December, we heard all of the same excuses, long-term rates are different this time, the two-year said they're not different, and it proved not to be different. So uncertainty goes to the tens, driven by bad inflation theories and bias at the Federal Reserve. Meanwhile, fundamentals go to the twos, especially at times like this, when you have an economy that's forgetting how to grow, and a mainstream media that forgets every other part of the yield curve. What you have to do is remember the twos. As far as the monetary fundamentals, I went over those in yesterday's video, drawn from the tick data, which had a lot of interesting stuff in it. That's the one linked below. As always, thank you very much for joining me. Huge thank you, Uridal University members and subscribers, and until next time, take care.