This particular Fed rule is still undefeated

In retrospect, it probably didn’t make sense to think the biggest Fed rate hike since 1994 would send stocks to the moon. Welcome to the bear market.

Things are looking ugly in late Thursday US trading, with Nasdaq Composite off more than 4 per cent and the S&P 500 down 3.1 per cent at pixel time. The Russell 2000 has puked 5 per cent. Things are bad.

A somewhat more worrying sign is that the high-yield bond market is looking wobbly. The major junk-bond ETFs are down nearly 2 per cent for the day and high-yield CDX spreads are starting to look spicy at around 600 bps. For context, they rose near 900 bps in the Covid mess and then retreated below 400 bps for much of last year.

The little green we see is the short-term Treasury SHY fund’s creeping 0.1 per cent higher, and the bunker-worthy staples of Walmart, food and personal-care companies. Are these bets that the only things Americans will be able to afford this year is food and soap?

There are signs of sharp positioning shifts and possible deleveraging, which should provide some minor comfort to those worried that it’s over: Even the long-term Treasury fund TLT is down a touch on the day, though yields are falling across the curve.

The market moves also fit with our new Fed rule: Whatever direction the market moves the day of the FOMC statement, it will move the opposite direction the next day. We can defend this rule primarily with the Baader—Meinhof phenomenon.

Wednesday was a 75 bps hike and risk-on trade, as Twitter predicted:

And then today we’re in a sea of red, like we predicted.

Keep the tin hats on for now. The Bank of Japan is meeting tomorrow, and with fellow NIRP stalwart the Swiss National Bank also jacking up interest rates this week, the BoJ is the last major central bank that still has monetary policy completely floored (with “yield curve control” pinning the 10 year JGB yield at below 25 bps).

If that goes then ooh boy. Here’s Krishna Guha at Evercore:

BoJ YCC is the last anchor of the old global yield curve structure via arbitrage conditions and flows. If it breaks the ramifications would be global, putting further upward pressure on yields in the US, Europe and Asia.

Foreign investors have been dumping JGBs aggressively this week testing the BoJ’s readiness to buy in unlimited quantities to defend the 25bp cap in anticipation that it might capitulate and scrap or reset YCC on Friday.

Our best guess is that the BoJ holds the line now for reasons we discuss in this note. But this has been an extraordinary week in central banking and we do not feel that we should rule anything out.

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