April 22, 2018 Authers Continued

Risk/Reward Vol. 390

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

Rumors that Cohen will cop a plea, another mistress ready to publish, a series of Comey interviews, the release of FBI memos, McCabe referred for possible criminal prosecution and the DNC suing Russia and The Donald's campaign---actually a pretty tame week in Trumpland. That said, not even continued strong earnings from money center banks and from recent market laggard GE inspired Mr. Market as the major indices closed essentially flat for the week. The biggest drag on stocks appeared to be the continuing rise in short term rates and the spike in the 10 Year U S Treasury yield. Indeed, rates/yields loom so important they warrant a deeper look.

Exactly one year ago the 2Year US Bond yielded 1.176%. It closed Friday yielding 2.45%. In fact it is trading where it did in August, 2008: a time before the collapse of Lehman Brothers, a time before the Great Recession and a time when the 10Year was yielding nearly 4%. On Tuesday, before its spike later in the week, the 10Year yield was a mere 41 basis points above that of the 2 Year, considerably below the long term average of 1% and the lowest spread to the 2Year in a decade. Historically, when the yield on the 2 year is less than the yield on the 10 Year (termed an "inverted yield curve") a recession is signaled. Thus, the sudden jump in the 10Year yield later in the week to 2.95% was viewed with relief by some economists even if not by Mr. Market. His enthusiasm was tempered by words from noted market bull Jeremy Siegel who is convinced that a 10Year rate of 3.25% this year will be bad for stocks.

So why is the 2Year rate escalating, John Boy ? (One of my nicknames in law school; despite never being a fan of The Waltons) Because unlike the 10Year, the 2Year is closely correlated to the Fed Funds (overnight) rate. And even though wags were convinced after March's Fed meeting that only 3 Fed Funds rate increases were in the ,cards for 2018, I pointed out that that opinion was based upon the vote of 8 of 15 members and that a switch by any one member could result in 4 increases this year. (See Vol. 386 http://www.riskrewardblog.blogspot.com/ ). Given the presence of inflation-creep (note the report from the Philly Fed this past week), the futures market is now pricing in a 44% probability that 2018 will indeed see four rate increases in 2018. The 2Year is merely reflecting that sentiment.

PS. I drafted this edition Friday afternoon after the close of the market. I should have waited and not wasted my time. Saturday morning's edition of The Financial Times has a column entitled "The Long View" written by my favorite financial reporter, John Authers. It is a much better explanation than mine of what is happening in the all-important US government bond market. In a word, the article is elegant. It can be found here: https://www.blogpvan.org/main/investors-cannot-ignore-the-message-of-the-us-bond-market/ I recommend it to your attention.