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The original was posted on /r/Superstonk by /u/BetterBudget on 2025-01-26 19:50:50+00:00.
Hey everyone, it's Budget here. There's a lot for me to go through so I'm going to start right now, but make yourself something to drink, and get comfortable, this is a fast read but it's going to set the tone for the week and potentially the next few months.
First, that pepe is supposed to be Jerome Powell. I guess he really decided to hang out with those Grateful Dead jammers and let his hair grow long. But, he's an important chess piece on the board.
Second, I'm going to dive into a subject that I'm not well versed in, so I'm not going to get to deep into these things, but I am a little worried about it so I thought I'd bring it up for discussion.
This is potentially part 1 of a longer series into macro through the lens of volatility but I'm going to try and run through the important pieces behind important forces, pressuring the monetary system, into making foundational level decisions that will impact markets and everyone else downstream. I'm going to start with long-dated US Treasuries i.e. bonds.
hint look at the Bond's MOVE
Let's get started.
This week Wednesday, Jan 29th, the Fed Reserve will announce its rate cut decision for FOMC at 2:00pm EST. The market has priced in a rate hold (no cut at this time) with 97.9% chance.
A rate cut is unlikely, especially with markets heating up, as JPMorgan's Jamie Dimon recently said "asset prices are kind of inflated" - source
So what stands out to me as being really important is what takes place 30 minutes after, when the fantastic Mr. Fox himself, Jerome Powell, gets up on that podium to answer questions about the committee's decision and forward outlook.
This is an opportunity for Powell to use cheap words in order to affect monetary policy, and I hope he takes advantage of the opportunity, as complex as it may be. For example, he can lay out a path of variables, like mentioning reports for markets to react to in the future, to anchor markets away from dangerous risks, in pricing in what the Fed may or may not do, from rate cuts to changes in their balance sheet and overall framework (e.g. there's the possibility of redefining QE as unhealthy!).
There are a lot of downstream implications being figured out between the state of the economy, what the Fed is doing during its rate hike cycle / fight against inflation, and the onboarding of a new president. This news presser gives Powell an opportunity to potentially lay out boundaries to protect the Fed.
But, before we can understand the reason why this is important now, we need to take a step back and look at a few things. And, at least for this DD part, I'm going to look at what long-dated bonds of the US Treasury market have been saying, since the beginning of the rates hike cycle or in other words the fight against inflation that started in late 2021.
For the past few years, during the rates hike cycle, there has been the inverted yield curve signal to the Fed pivoting over a year ago as if the fight against inflation was coming to an end (source). There have been risks in the market that through regulation, forced particular kinds of funds (e.g. pension funds around the world) to buy "risk-free" safe assets, such as these long-dated Treasury bonds.
Let's look at a chart of the lower end of these bonds, where there's actually less stress... with the US 10 Year Bond Yield.
If you are unfamiliar with bonds, an important starting fact is when yields go up, the value of the bonds go down and as yields go down, the value of the bonds go up 🧠
The rates hike cycle started March 16th 2022 with a 25bps rate hike, and the discussion over the rates hiking timetable accelerated, further backin November 2021. There was an increase in "option-implied volatility on short-dated interest rates", that alerted the Fed to start hiking sooner and quicker, more aggressively.
Interest rate vol was cheap in 2020 and did great in 2021.
The Fed is 100% data-driven. They watch multiple metrics, including volatility over various markets. It's a decent proxy into where they might need to inject some liquidity.
So over this period, with this risk-off signal for macro traders in equities (remember, the S&P500 entered a bear market into 2022 with almost a 20% pullback in the first few months), safer players like pension funds, in effect, sold equity and bought the dip in bonds, over and over again, starting in 2022.
But, the "dip of the dippity dip dip" has yet to come.
Spoiler alert, 6.25%+ yields on US10Y is on the table this year! Ya...
The buyers do not have much dry powder left, and so demand for long-dated bonds is low. What's worse for them is that on paper, there bonds are marked as losses, just look at the chart below.
They got duped, in part, because bond traders hadn't seen 5%+ yields since June 2007.
Yields went down since then into about 2020. So the value of bonds went up during that period, and for many, who've been doing business as usual since then, with real market indicators saying buy the bond dip, like since that green vertical line, yields have gone up, their holdings have gone down in value.
Meanwhile, the US continues to spend more money than it makes, the classic debt/GDP problem. Look at the Fed's chart of debt as a percentage of GDP. It impacts this problem with the bonds market because spending more money means the US will have to issue more debt, which is US Treasuries, thus the US needs to increase the supply of Treasuries, as a consequence of this cash flow imbalance. Therefore, long-dated bonds, an asset with already weak demand, with traditional buyers under-water, have a growing concern for its liquidity and thus its volatility.
These are supposed to be risk-free assets!!!!! 🤯 Da fuq.
That brings us to the present, where there is a growing concern about bond yields going up and who is going to buy them❓
Consider how the market reacted to the Fed's first rate cut last September 18th, 2024. You would expect yields to do the opposite from the start of a rate hike cycle, for them to go down, as we are at the end of a rate hike cycle, but they didn't!
The Fed cutting rates sent a signal to the market that in effect, the fight against inflation is coming to an end, and thus markets should begin to price in a soft landing, maybe sell off some equity, and buy the dip on bonds. But, the bond market instead, pushed back in hard disagreement. Bonds sold off, as seen above, with long-dated yields going UP to a new high 🆙
Poor bonds traders 🫂🫂🫂 Doing the responsible trade and just getting rug pulled by a complex situation.
Now, if you've never heard, the MOVE index is essentially the VIX for bonds. Take a look at what it did during that time:
That caught the attention of the Fed. Bond vol, as you can see above, made new highs last year by mid-November, increasing 50%.
Now, there is a lot more to this than I'm going into, but I'm trying to get to my point quickly, with enough foundational knowledge so you kind of get it the main concern ⚠️
It's in effect a warning sign, that bond traders are in a sticky situation, and what it says about the long-term fight against inflation. It's just not over yet, and in a way, it implies something worse...
There's an imbalance of supply/demand for long-dated Treasuries. With that continuing, it's going to affect other markets downstream like FX. One probable outcome with a strong probability is the strengthening of the US dollar i.e. rising in value.
That's bad for equities, emerging markets, and other currencies around the world. The US dollar, the reserve cu...
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