Bond Voyage

Jay Powell is about to do what he should have done six months ago. He's about to remove the fix from fixed income. Given all that has transpired since the FOMC formulated this policy, it seems a bit late don't you think?

The Fed is finally getting serious about reversing a policy designed for another era. Trapped by their rigid adherence to their Greenspanian communication strategy, they must follow through or lose any remaining shred of credibility. Tomorrow we get to see if they have the courage of their suddenly wavering convictions. This has the bondies running scared. Jeffery Gundlach, the self-anointed 'Bond King' was out talking up his bearish position on bonds by predicting $200 oil in a widely quoted post. Having 'priced in' at least seven 25 basis point rate hikes, the market had been preparing for higher rates even before the war-induced commodity spike. The fear factor of a potential global shortage in commodities was gasoline on a fire. Investors piled into oil, copper, and gold, shunning bonds, with Gundlach as captain of the cheer team.

Hey Jeff - I have some advice. Stay in your lane.

The commodity blow-off is quickly unraveling this morning. Hard assets were widely assumed to have no downside in an inflationary environment. Unfortunately, in this world of unpredictable and volatile markets, they in fact do respond to rapid shifts in sentiment as we have just seen. When financial speculation is mixed with scary headlines, markets often run to extremes. Oil is like water, it seeks its own level.

Adding to the confusion is the convoluted China story. Their stock market has crashed, caught between the 'rock' of regulatory overreach on technology and the 'hard place' of a real estate collapse. The failure to accept the reality of failed Zero Covid policy is now piling on more bad news. Bejing bureaucrats apparently believe they can control a pandemic by issuing shut-down press releases instead of developing effective vaccines.

Downward revisions to the China GDP forecasts are piling up, with Goldman Sachs postulating a '0' call. Seems extreme to me, but with a global risk purge in full swing, reducing allocation to China is a time-honoured response. I have always avoided any direct Chinese investments. Their 20-year charade of 'free' capital markets never fooled me. There are no equity ownership rights in a land of government command and control, as investors in $BABA and $TCEHY have suddenly found out. A chart (below) of emerging market ETF performance - $EMXC, ex-China vs $EEM, with China - is striking.

EMXC/EEM

So unless we see an unexpected resolution to both the war and the China slow-down, I don't think the inflation story and the consequent path to higher rates are as simple as first thought. And the path to 'normalization' that was laid down in the Fed OMC meetings just weeks ago is now littered with potential speed bumps and potholes. Long bonds are now offering diversification benefits and competitive yields for the first time in years. Recession risks alone argue for their inclusion in any diversified portfolio. There is a bond rally in the making just from a mean reversion trade. The hugely crowded trade of 'short bonds' now looks like a Tom Brady retirement party - just a bit premature.

And good luck with this mess, equity risk-takers. I'm still sitting this one out.

Risk Model; 1/5 - Risk Off

Not much change in the model as the Canadian advantage I discussed last week is giving some back today on lower oil. A commodity soft landing is desperately needed for that trade to work. Stay tuned.

Off to ride my bike. At least I can see the road ahead there.