Highly rated rates

Stocks tumbled for yet another session as investors could not shake off fears of higher interest rates. Fed officials are pressing the message of aggressive action against inflation – stocks are not happy about it.

Silent killer. Who doesn’t like a nice story? There is a lot to talk about when discussing stocks with family, friends, and colleagues. There is interesting news, personalities, products, projections, industry prospects…the list goes on and on. I can literally drone on for at least an hour on any given stock. If the numbers line up with story, investors gain more confidence in their decisions to buy or sell. To be clear, it is not a game, but many investors make a hobby of stock investing. We get it, investing in stocks can be interesting…especially if you are profitable over the long term.

Bonds on the other hand…well they are less exciting. Not much to talk about. If it is a corporate bond or a municipal bond, sure we can talk about the issuer along with news, stories, executives, etc., but with bonds it’s all about the credit worthiness of the issuer and the details about the bond itself. When does it mature? In other words, when does it pay back face value principal? What is the coupon? What is the yield to maturity, which takes into account your coupon payments, when the bond matures, and what you pay for the bond? Did you buy it at a discount to par or a premium? Is it callable by the issuer? What, if any, collateral is the company offering to make sure you get your payments on time and that you get your principal back? For many, bond math and investing are complicated, and not quite as exciting as stocks. Most investors are interested in one thing, however, and that is yield. Of course, there are many things that go into deciding whether to buy a bond, but yield is typically the defining factor. When it comes to bond yields, it all starts with US Treasury Bills, Notes, and Bonds. US Treasuries are considered the least risky asset on the planet, backed by the full faith and credit of the United States. Corporate and Municipal bonds are priced based on yield spread to US Treasuries of similar maturities. When Treasury yields go up, as they have been, yields on corporates and munis go up as well, and vice versa. So, Treasury yields are important for bonds. This past year has also offered a painful reminder that Treasury yields are important to stocks as well.

The majority of issued bonds are held by institutions and purchased to be held to maturity. Of course, they can be, and do get, speculatively traded, but most investors, including retail investors, buy them to be held to maturity. Because of this, bond yields and prices tend to be less volatile than stocks, and they offer a more leveled view of inflation, the economy, and policy (both monetary and fiscal). That is why wise investors always take their cues from the bond markets, even when buying stocks. Last Friday, Chairman Powells hawkish-leaning speech sent stocks into a tailspin, while bonds hardly budged. What does that mean? Well, we have to zoom out to get the answer. If we look at the 2-Year Treasury notes, we can see that yields rose in the days and weeks PRIOR to the Chairman’s speech (check out the chart below). Yields on the 2-Year note attempt to predict where short-term interest rates are going to be in two years. In other words, bond traders already anticipated a more hawkish Fed, while stock investors were taken by surprise…surprisingly. Unfortunately, it is not just the 2-Year Note yield that is telling us something. The 10-Year Treasury note yield reflects economic health and inflation over the longer term, and when those yields are not climbing as fast as 2-Year yields, it means trouble ahead, especially when they offer lower yields. The inverted yield curve, which I have covered often here in this note, remains inverted and that negative spread in yields has intensified in the past 2 months. That yield curve inversion has pre-dated 10 out of the last 10 recessions. Bonds may be boring to talk about, but when they talk, we should all listen… carefully.

YESTERDAY’S MARKETS

Stocks fell yesterday as investors continued to weigh a more aggressive Fed. The S&P500 lost -1.10%, the Dow Jones Industrial Average fell by -0.96%, the Nasdaq Composite Index traded lower by -1.12%, and the Russell 2000 Index dropped by -1.45%. Bonds rose slightly and 10-Year Treasury Note yields were flat at 3.11%. Cryptos gained +0.08% and Bitcoin fell by -1.0%.

NXT UP

1. ADP Employment Change (August) is expected to show +300k new hires for the month. This number returns after a brief vacation while the sponsors changed its calculation methodology. It is thought of as a precursor to the Government’s official number on Friday, though it has not been a good predictor recently. Perhaps the changes made will bring it back in line. Pay attention because Friday’s number is really important to the Fed.
2. MNI Chicago PMI (August) is expected to remain unchanged at 52.1.
3. Fed Speakers: Mester, Logan, and Bostic. More tough talk?