Lower Oil, Dovish Fed Can’t Stop the Bond Selloff
The problem clearly runs deeper than the next Federal Reserve meeting.
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It was another poor day for the market, with only about 40% of stocks positive and new lows swamping new highs by roughly 400 to 60. The losses in the indices were not as severe, and the Invesco QQQ Trust (QQQ) posted a small gain on positive chip-related activity. The most notable action, once again, was in bonds, which stayed under pressure even though the two things that should have helped them didn’t.
Oil prices dropped on hopes for diplomacy with Iran, and Fed commentary turned more dovish. New York Fed President John Williams said one more rate hike this year may be appropriate, but there is no urgency to act after the move earlier this month. The market heard that loud and clear. The odds of a hike at the October 28 meeting fell to 51.5% from 71% on Monday, according to CME FedWatch. Bonds closed lower but did bounce intraday.
Pressure Is Structural
When bonds can’t rally on lower oil and a dovish Fed comment, the problem runs deeper than the next Fed meeting. There is simply too much government paper to absorb, and investors want a better rate before they commit to holding it for decades. Add in sticky inflation outside of energy and the enormous capital demands of the AI buildout, and you have a bond market that doesn’t need the Fed to keep rates elevated.
That matters for stocks because the rate pressure is what has been crushing everything outside of AI. As long as long-term rates stay near these levels, it will be hard for the broad market to find support, no matter what the Fed says.
Bottom Calls and Quarter End
The calls for a turn in bonds are growing as they become oversold, and there may be some help on the way. Goldman Sachs estimates pension funds will need to buy about $33 billion in bonds and sell a similar amount of equities for month-end and quarter-end rebalancing. That could remove some of the pressure on bonds, although it is a headwind for stocks over the next day or so.
A turn in bonds is one of the changes of character I’ve been waiting for, and it would go a long way toward setting up the fourth-quarter bounce I discussed on Tuesday morning. But an oversold bond market that bounces for a couple of days on rebalancing is not the same as a turn. We need the trend in bonds to change, and I want to see it in the price action after the quarter-end flows are done rather than in the forecasts.
Game Plan
My approach doesn’t change. I’m staying patient, keeping plenty of cash, and building positions slowly in names I like. The bond market is the key to the whole picture right now, and when it does turn, there will be time to act. Better late than early.
Have a good evening. I’ll see you tomorrow.
At the time of publication, DePorre had no positions in any securities mentioned.
