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The Bear Market You SHOULD Be Watching

The stock market finished the week with a strong rally on Friday leading the usual suspects into their favorite Bubblevision chant:

Of course there are some rational people out there who pay attention to the big picture and they are called “bond traders” aka, “the smart money.”

While the rumors of a Fed rate cut permeate the market already due to an undeclared recession while inflation is still increasing, the reality is that there are still market moves which do not ignore the baseline assumptions of the rate of inflation and what the Federal Reserve must commit to or else they will trigger a 1970’s stagflationary winter.

The markets have not fully digested, nor are there enough traders from that era still around, to understand the implications of higher persistent inflation. Thus far my favorite measure, the Federal Reserve Bank of Atlanta’s Flexible CPI is still above 18%:

If the Sticky CPI (their version of PCE) at 5.2% is any indication, the ascension of a longer inflationary trend is just beginning rather than contracting. Other than a short term dip in commodities, everything in the manufacturing and service sector seems to validate this trend via the Producer Price Index. The CPI lags the PPI impact by anywhere from 6 to 12 months, thus the higher numbers we have witnessed in the PPI have yet to hit the markets in a substantive manner. Those poor souls hanging their hat on lower commodity prices will mean an end to inflation have not paid too much attention to what happens to the world’s reserve currency and how the energy and supply chain really operates.

Meanwhile in the bond market, the HYG is a very speculative ETF on just what is happening in the junk bond markets and where those yields might be heading. The recent action is not reflective of a recession but rather of another meme stock type of speculation as the risks of a major pull back are quite real.

During the 2006-2010 Great Financial Crisis (aka, mini-Depression 2.0), the HYG appeared on the markets in April of 2007. The ETF suffered greatly during the crash and might provide some guidance as to where the current market might be heading. This is the current level of the HYG as displayed in this four year plus chart of the ETF:

Even after the intraday high above $85 this year, the risk of retesting the long term support levels around $67 is now in play. A violation of this could mean risk averse bond traders may realize that the inflation will be uncontrolled heading into the autumn and worse, the 2008 and 2009 lows are viable price targets. If that happens however, there is strong support from early 2009 as the chart from the GFC era indicates:

Conveniently, the 33 area would be a perfect 61.8% retracement from the 2022 high in HYG.

In the 10 year US Treasury market everyone in Bubblevision land has been focusing on the yields, but not on the price and the technical relationship to the yields. In reality, the bond bear market is just beginning to wake up as so far it has just been a baby bear while mom and pop continue to hibernate.

The Federal Reserve has been talking a good game but the bond traders are not buying it. Why not?

Perhaps it is this indicator which basically calls out Jay Powell and the clown show he oversees as a joke:

In other words, QT is all talk, no action. There has been less than a 0.01% reduction in the size of the balance sheet thus far so the “serious” talk about attacking inflation head on is total nonsense. The long term bond market has sniffed this out and once the market rolls over after this short term rally support for the 10 year Treasury becomes critical. The problem Powell and his equity trading group will soon realize is that inflation can not be “talked” down, it requires a dramatic reduction in the assets on hand and the monetary base, aka, a reduction in credit.

This chart from the GFC era and start of Quantitative Easing of the 10 year US Treasury highlights where this market is going by the early autumn in this author’s opinion:

If the 112 price support level fails, then 104 has to hold or a retest of the mid 90’s level is conceivable. At that point in time, a failure with prices crashing towards a price level around 80 is possible, which would mark a grand twenty year round trip of Federal Reserve expansive policies. I doubt the Fed would ever allow that however due to the political firestorm that would occur.

Watch the smart money folks as mama bear is about to wake up and cause some horrible carnage in the markets setting the table for papa bear to initiate the newbies into what a real long term stagflationary bond and equity market looks like.

Also, remember this important fact my friends:

If the Federal Reserve panics due to a slowdown in economic growth and under political pressure turns the monetary pumps back on to full, the United States is truly at risk for a Weimar style hyperinflationary crash as trillions of dollars return home and half of the economies in the world abandons the “world’s reserve currency” for a more stable alternative.

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