Imagine you’re standing on the harbour bridge looking down at the Opera House and next to it you see a two man tent.
If the two man tent is the stock market then the Opera House would be the bond market.
And just like the Opera House, most people ignore the bond market after a couple of visits and head up town looking for something more exciting.
(BTW – bonds are like term deposits only they’re traded on an open market similar to stocks and shares.)
The problem with the bond market is despite its size and influence, most investors look straight past it until it’s too late.
Which is exactly what happened this time four years ago.
When we came out of lockdown, the Opera House of the financial markets was making more noise than the New York Symphony Orchestra.
Specifically, it was warning us inflation would scream and interest rates would go up well before 2024.
But the Federal Reserve and the RBA ignored all the music which got louder and louder…until inflation got so high they were forced to hike rates.
And guess what?
The bond market is singing from the same hymn sheet again.
Since the US Fed cut rates by 50 basis points last month, bond yields have shot up rapidly.
Meaning, the bond market believes rates were cut too deep and will catalyze another wave of inflation.
But unfortunately, it doesn’t end there.
The markets now believe Trump will win the election and push inflation higher.
Trump is an inflation risk for two reasons.
Firstly, he wants to cut taxes which will increase disposable income and fan inflation.
Secondly, he wants to introduce tariffs. Tariffs might protect an economy but they also reduce competition and put upward pressure on inflation.
Aggressive tariffs can also lead to trade wars.
To quote Trump, “… tariff is the most beautiful word in the dictionary.”
So what if Trump doesn’t win?
It doesn’t matter because all roads still lead to higher inflation, including Australia.
Which brings us to rates…
Two weeks ago in my Moowsletter, ’Time To Lock In Rates’, I opined we could be at the top of the rate cycle.
However, US bond yields (10yrs) are currently oscillating around 4.25% and could easily jump one or two percentage points to circa, 6%.
If that happens, bond yields will put massive upward pressure on US rates.
And here comes my backflip…
For the eighteen months prior to my Moowsletter a fortnight ago, I told readers to expect the RBA cash rate to land somewhere around 5%.
That’s now back on the table…an RBA cash rate of 5% in 2025…which means a few more rate hikes.
And if that happens, the stock market will look like a punctured air-matress.
Have a great weekend!
Adam
Back paddock – a financial crisis percolates for years and blows up in weeks – Paul Tudor Jones, Hedge Fund Manager
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