by EconMatters, EconMatters.com
James Bullard Speech
The biggest news to come out of Friday’s financial market activity was James Bullard’s thoughts on when he expects the Fed to start raising rates, he believes the Fed will start raising rates sometime near the end of the first quarter of 2015.
According to slides for his speech, he also said,
“While first-quarter GDP growth was weak, growth in coming quarters is still predicted to be robust. The average quarterly pace of growth in 2014 may still be an improvement relative to 2013.”
But the Fed may raise rates even sooner as we have thought that the market has become too complacent with regard to the Fed “talking down the market” which is at odds with the robust economic and inflation data of late, and the Fed will be forced to address the sharp rise in economic conditions of the second and third quarters “The FOMC would be ready and willing to get more aggressive if it was required,” including if inflation surged unexpectedly, he said. Another surging PPI report in the same direction fits this category in our opinion.
The bond market is really asleep at the wheel right now in our opinion. With the recent surge in bond prices, right before a sea change that has been 6 years in waiting, the raising of the Fed funds rate is about to begin, and there are a whole bunch of folks on the wrong side of this trade, and all this money is going to have to come out of the bond market.
Further Reading: The Worst Risk/Reward Trade on Wall Street
Market Squeezes Go Both Directions
Jeffrey Gundlach of Doubleline Capital has been talking up the notion of a bond market squeeze which of course would be good for his fund and his current positioning of the last six months, but squeezes work in both directions Jeffrey Gundlach, and there is far more money long the bond market right now than short, and yields are very depressed right before a sea change in terms of raising rates by the Fed.
All this long money has to come out with rising rates, I am sorry Gundlach but the real squeeze is going to be in the other direction after six years of a near zero Fed Funds Rate, rates are going to be raised and normalized, and according to James Bullard and Janet Yellen the fed will be targeting a normal short-term policy rate of 4 percent to 4.25 percent.
Six Years is not a Lifetime: Historical Interest Rates as Contextual History Lesson
The writing is on the wall, after six years of extremely loose monetary policy rates are going the other direction in the United States; and England is going to follow suit as their economy and inflation concerns have been on the rise as well, expect rate hikes likewise coming out of England in our opinion.
Thus all this money came rushing into the bond market right before actual rates are going to be raised, talk about great timing and squeezes, over the next five years this is going to be one of the massive squeezes of all time, and in the short-term the 10-Year yield is going to blow past 3% faster than you can say December.
Remember those PPI, CPI and Employment reports are going to be hitting the Fed with an inflating and accelerating economic reality, and the Fed may be forced to act even sooner than 9 months with a couple more hot PPI and CPI reports like last week, and several more 250k plus Employments reports, it is going to get downright ugly in the bond market as all those longs of six years run for the exits under a normalized rate environment.
Further Reading: May’s Employment Report To Top 300K
The Levered up Yield Trade & The Unwind of Fund Flows
Accordingly, thanks Jeffrey Gundlach for being mindful of squeezes in the bond market, because we are right at the precipice of the biggest Short yield squeeze in the entire history of the bond market with the actual raising of interest rates by the Federal Reserve after six years of extraordinarily low short term rates in terms of monetary policy that created artificially low yields that are about to adjust much higher or normalize.
Just think the amount of money levered up to chase yield because there has been so much cheap low interest rate money to borrow, and leverage up the yield trade, artificially pushing yields even lower, all this money has to be unwound with the raising of short-term rates – this is the worst carry trade in the history of financial markets right before a sharp upturn in short-term interest rates and a massive re-pricing of the entire interest-rate market!
Calculate the massive amount of funds, derivatives and hedges that now have to start unwinding in the other direction – talk about wrong-footed and mispriced markets!
Investors currently looking at the wrong market for being a bubble: hint it’s not Google
Everybody has talked about the bubble in the bond markets for six years, but with each passing year and near zero percent interest rates, more complacency has sunk in with the status quo thinking that this low rate environment is the “new normal”. But this couldn`t be further from the case if we review what constitutes normal short term rates, and this complacency was reinforced and even perpetuated by the Federal Reserve itself with their dovish talk and actions of the past six years.
Now that the interest rate environment is about to change, and everybody should be on their toes, all the bond participants are in a sleep induced coma, and asleep at the proverbial wheel, not being prepared for the shock of their investing lifetimes. Yes short-term interest rates are going to rise in the United States and England in anywhere from six to nine months’ time – and the entire investing community is poorly positioned, and on the wrong side of the market. The bond market bubble is about to burst folks!