| If you thought the bond market had got its story straight, think again. On the anniversary of its brief trip above 5%, the 10-year Treasury yield is surging upward once more. In the wake of the Federal Reserve’s decision last month to make a jumbo cut of 50 basis points to the fed funds rate, the 10-year yield dropped below 3.6%. It’s now above its 200-day moving average, at 4.19%. The helter-skelter ride continues:  Why the change of direction? Chiefly, there is a reassessment of the Fed’s likely next move. In the wake of the jumbo cut, the fed funds futures priced in further cuts of 100 basis points by January’s meeting. That meant certainty that there would be at least one more big cut. The surprisingly strong employment data for September reined that in drastically. Since then, the expected cuts have continued to whittle away, and now the market thinks that there will most likely be only 50 basis points of cuts over the next three meetings. From pricing a certain jumbo cut, they are now positioning for a likelihood that there will be at least one meeting when the Fed stands pat: This seems a largely sensible response to ongoing Fedspeak, as speakers from the central bank are beginning to tell us all in pretty clear language to forget any more out-sized cuts. Jeffrey Schmid, president of the Kansas City Fed, said he favored a “cautious and gradual approach to policy”: While I support dialing back the restrictiveness of policy, my preference would be to avoid outsized moves, especially given uncertainty over the eventual destination of policy and my desire to avoid contributing to financial market volatility.
Neel Kashkari of the Minneapolis Fed similarly said that he would need “real evidence” that the labor market is “weakening quickly” before he would deviate from a cautious path aimed at getting to a neutral rate (often known as R*): Right now, I am forecasting some more modest cuts over the next several quarters to get to something around neutral, but it’s going to depend on the data.
Lorie Logan of the Dallas Fed argued for “a strategy of gradually lowering the policy rate,” while Mary Daly of the San Francisco Fed was less hawkish in comments Monday, saying she did not want to see the labor market loosen further. But she did nothing to stoke the notion that more jumbo cuts lie ahead, and admitted that last month’s decision had been a “close call.” The commentariat is also shifting. Apollo Management’s Torsten Slok suggested that there was a chance the Fed would hold at the next FOMC meeting, due in election week. But it’s not just about the Fed. As much discussed, betting markets have shifted strongly toward predicting a victory for Donald Trump. In the last few months, it’s striking that the 10-year yield has traced the Trump odds according to Polymarket — an offshore market that may be over-influenced by a few large bettors, but which seems to be driving opinion on Wall Street. The following chart is on two scales, but still captures the way the bond market has evidently moved in response to the campaign:  Tax cuts, as promised by Trump, would tend to be expansionary and prompt higher rates from the Fed. Also, as former New York Fed President Bill Dudley explains for Bloomberg Opinion, “across-the-board higher tariffs would both raise inflation and hurt growth” — which would entail higher rates. Amidst all this, the stock market has somehow not sold off, thanks Monday to strong performance by the large chipmakers. This follows the template set by the first “Trump trade.” That said, his victory in 2016, and the tax cuts and tariffs that followed in the next two years, spurred a big rise in bond yields while stocks massively beat Treasuries. It’s no surprise that people are positioning for this again:  There are important differences. The PredictIt prediction market put Trump’s chance of victory at 22% on election eve in 2016; the same market now puts him at 58% (while others rate him higher). So whatever happens in the next two weeks, we can assume that a Trump victory wouldn’t provoke quite so big a reaction, because it wouldn’t be such a big surprise. Investors are already attempting to price it in. In fact, it looks as though they’ve overdone it. The pro-growth trade of buying stocks relative to bonds continues to surge. The following chart uses my favorite simple measure employing exchange-traded funds, and compares SPY (tracking the S&P 500) and TLT (tracking Bloomberg’s index of 20-year+ Treasuries). This chart also has an obvious family resemblance to the perceived ebb and flow of Trump’s chances through the year:  Some historical perspective might be handy. Stock outperformance like this is not normal. These two ETFs have been available since 2002. This is how the trade has performed since TLT was launched: By the time Trump won election in 2016, stocks and bonds had been tracking each other for more than a decade, characterized by the bursting of the dot-com bubble, the Global Financial Crisis, and then years of bond-buying by the Fed that tended to buoy both asset classes. That election spurred the first big Trump trade — which culminated in the alarming selloff now known as the Christmas Eve Massacre at the end of 2018. Then the Fed’s massive bond-buying to deal with the pandemic prompted a reversal. Since then, it’s been one-way traffic, uninterrupted by the arrival of Joe Biden, or the Fed’s aggressive monetary tightening in 2022 and 2023. Whether stocks could continue to rally like this amid a trade war, growing bond yields, and rising inflation is another question. The stock market eventually revolted against the Fed’s intention to continue with monetary tightening on “auto-pilot” back in 2018, and forced what’s become known as the Powell Pivot back toward easing. Inflation was much lower then, and it’s not clear that the central bank could so easily stage such a retreat again. But the greater issue, for now, is that all these scenarios are being elaborated before the election has even taken place. Digging through my old cuttings library, I find I wrote two days before the Brexit referendum that the pound was trading “as though the referendum were already over and the UK was staying in the European Union.” It wasn’t. Those who bought up sterling early that week lost an unseemly amount of money. We don’t know how the 2024 presidential election will come out, but it does look, once again, as though markets are trading as though they already know the result. They don’t. One problem with trading on the basis of an election result is that you can never be sure of the consequences. For a remarkable case in point, look at the fortunes of the dirtiest form of energy, as proxied by the Range Global Coal index, and the cleanest, proxied by the S&P Global Clean Energy index. Donald Trump famously hates windmills. His biggest policy proposal to reduce inflation is to invest in producing even more domestic fossil fuels. Democrats’ problems are intense in regions most tied to fossil fuels. Kamala Harris has been forced to go back on an earlier commitment to ban fracking. On few issues is the difference between the parties in this polarized election so stark. So, of course, the coal index tanked relative to clean energy under Trump, and then went on an epic rally that started the very day Joe Biden toook office. Since inauguration day in 2021, coal has beaten clean energy by 800%. The following chart is normalized so that the ratio between the two indexes is 100 on the first day of the Biden administration: To the extent that Trump didn’t like windmills and Biden wanted to persuade people away from fossil fuels, both of them did a really terrible job of persuading capital to flow in the direction they wanted. Beyond that, some of this bizarre outcome can be traced to traders trying too hard to price a political outcome. With the election coming, they naturally got out of coal and bet on clean energy, establishing the conditions for a great turnaround. Coal’s recent bounce probably includes some optimism for a Trump restoration. Beyond that, Bloomberg’s Big Take goes into a fascinating detail on what it calls The Climate Short. Hedge funds have been sedulously betting against green energy stocks, without courting any great publicity for it, while the geopolitical situation has made life harder for those trying to spur investment in new technologies. Amid great uncertainty, it’s made more sense to rely on established and reliable energy sources, and US oil production has even risen to a new high under Biden. A lot rests on the result of the election. But we still need to know what happens next. Whoever wins, even when the policy choice seems as clear as it does on the issue of energy, that’s not obvious. This is for those rare individuals who finish reading this newsletter and immediately feel the urge to go through another big screed of market analysis. Our regular market email service has just had a revamp, and it’s a really good and informative read. Here is a recent issue for your perusal. You can subscribe here. Happy birthday to Franz Liszt, born 213 years ago. The great composer and pianist (and scandalous lover) has been portrayed in film by Roger Daltrey (in Ken Russell's Lisztomania), Julian Sands (in Impromptu), and Dirk Bogarde (in Song Without End). He also shows up in Desire for Love (about the other great pianist-composer Chopin). There’s great theatricality in a Liszt performance, but he was much more than just a show-off. There's real intensity in the music: try the irascible Sviatoslav Richter acting the role, and playing his Sonata in B Minor.
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