If you want to know what direction the markets are going in, equities traders should watch what bond traders are doing. The bond market is a much bigger market than equities, and when there is a whiff of inflation, bond traders and investors will walk – or even run – out the door (they are quite paranoid).
Long bond traders have been dealing with a flatter yield curve and mildly rising interest rates. Even though some inflation has been coming into the economy, it has not been enough to scare them off. But that could be changing.
Watch the bond traders
If you look at the recent data, you’ll see some hot inflation numbers (PPI, wage growth, unit labor costs) and some weakening economic data. The housing sector is in shambles while many technology and retail groups are in/near a bear market. Even though the indices are not anywhere near a bear market, it sure feels like it.
(Let’s remember my definition of a bull and bear market. A bull market is one that goes up, and a bear market is one that doesn’t go up. Hence, even a sideways market for a period of time could be considered bearish.)
But something interesting is happening with bonds. Strikingly, they have been up for the past several days, perhaps indicating a change in sentiment. Maybe bond traders see a weaker economy despite some higher inflation numbers, and they are getting in front of a potential pause in interest rate hikes.
We often see the bond market doing the Fed’s work for them, and that is somewhat of a relief to the Fed. It means they don’t have to manage the chaotic equities market. The drop in yields is curious and needs to be watched as bond sales continue to spread to the markets by the Fed and other entities.
Make no mistake: Yields are elevated, because the bond market is still rattled by the Fed’s language. In October, the yield curve surged twice, but it experienced a recent decline. Watch it closely to see if there is more to come.