I’ve Got My Eye On The Bond Market Right Now (But I’m Still Trading…)
Last week, I noted that interest rates were rising — an ongoing trend that could present risks to the stock market.
As I noted back then, Federal Reserve Chair Jerome Powell seemed to be trying to reassure the bond market that the Fed will be on hold and rates should remain low. But that hasn’t stopped bond traders have been selling bonds, which in turn has been pushing rates up. In fact, rates were rising faster than at any time in the past 20 years.
On Thursday, rates spiked significantly higher.
Cue the selling. After Thursday’s rate spike, the S&P 500 fell nearly 3%.
Last week’s market action is being called a tantrum, reminding investors of a 2013 selloff that followed comments from Ben Bernanke, the Fed Chair at the time. At that time, the Fed had just announced its plans to taper quantitative easing.
This time, one Fed official noted that rising yields are “driven by a more positive outlook for the economy… and maybe, you know, a more stabilized view of inflation versus where we were before.” Another official said he isn’t worried and that he’s “not expecting that we’ll need to respond in terms of our policy.”
Private economists believe the Fed will need to act relatively soon. According to Wall Street Journal:
“We think Fed officials will change tactics and intervene verbally. Most likely they will emphatically affirm their patient and dovish stance, which accords with their new policy framework.
A repeat of last week’s disorderly jump in yields would threaten the economic recovery. Policy makers will need to walk a fine line between calming impatient bond markets while not sounding too sanguine about higher inflation risks.”
What This Means
I agree with private economists that the Fed will be acting soon.
There’s a technical reason to expect the Fed to act, and it has to do with the way banks account for Treasury securities that they hold. Standards were relaxed in 2009 in response to the financial crisis. As a result of the rule change, banks added Treasuries to their balance sheet.
The relaxed rule is set to expire on March 31. If the Fed allows the rule to expire, banks might be forced to sell Treasuries, which would send interest rates higher.
Experts noted that if the rule changes, banks “can get rid of deposits, back away from Treasuries and overnight lending, pare corporate and mortgage loans, raise capital and reduce stock buybacks that the Fed recently allowed them to resume.” Each option has pros and cons for market stability and profits.
For instance, JPMorgan’s Chief Financial Officer Jennifer Piepszak said the company might issue preferred securities to boost capital. Analysts believe that would lower earnings per share (EPS) and could affect the stock price.
This story will be important to watch because it affects the bond and stock market. I’ll be watching and will let you know if there are significant changes in the way banks manage their balance sheets.
How I’m Trading Right Now
For now, I believe it’s still safe to pursue short-term income opportunities like my recent recommendation in Advance Auto Parts, Inc. (NYSE: AAP).
AAP is on an Income Trader Volatility (ITV) “buy” signal, which you can see in the bottom panel of the chart below. For those who don’t know, ITV is the award-winning indicator I personally developed to identify trading opportunities over at my premium service, Income Trader. Our success rate with trades over the years is above 90%, largely thanks to this invaluable tool.
This indicator is based on the stock’s volatility, similar to how the VIX is used for volatility in the broader market. In the panel at the bottom, you’ll see two lines that indicate a “fast money crossover” — the red ITV line that represents fear/volatility and a blue line representing its moving average.
Because it’s a volatility indicator, declines in the indicator are associated with uptrends in price. The recent cross of the indicator (red) below its moving average (blue) is a “buy” signal in AAP.
Now, a lot of investors would take this as a signal to merely buy AAP. But that’s not how we do things over at Income Trader. I’m focusing on safety, especially right now, so our strategy involves protecting our trading capital and making a short-term trade that puts money in our account instantly.
This provides a margin of safety if the broad market does sell off. It also allows us to get paid right away.