We are all watching bond yields as a precursor for the currency market

Outlook

We are all watching bond yields as a precursor for the currency market. This is probably a mistake because the correlation is not always strong over short periods. A lot depends on why yields are falling. This time it seems to be the expectation of the Fed on hold at the Oct 28 meeting but after that, all bets may be off.  Other factors include a rush to safety as the tech sell-off scares the faint of heart. New corporate debt crowding out the government and those old stand-bys, inflation and sovereign over-indebtedness, are mysteriously off the table for the moment.

Last week analysts settled on the tech sector/AI issues, especially circular funding (chip sellers lending to their customers to buy their products when they have no credit training). This has the potential to be the real trigger and if so, we are in for a world of hurt.

We guess that it will abate, if only because the stock market is addicted to wishful thinking.

Besides, it’s a fearful scenario, not a reality, if based on some factual stuff. But inflation and government over-indebtedness are real and present right now. It would be foolish to imagine they will go away. They are just superseded at the moment.

You have to wonder what TreasSec Bessent might do if the outcome is ongoing distress in the tech sector—bailouts? Guarantees? He had no luck bringing yields down with his buy-back plan, which put a dent in his reputation. As for the real top factors, he lacks the power to do anything about inflation or indebtedness except maybe jigger the tenors. Analysts wonder what Bessent and Warsh talk about at their weekly breakfast meeting. Do they have a Plan A and B and C?

It’s important that the 10-year yield stopped short of exactly 5%. That may be a floor in the face of the return of inflation fear coming hot on the heels of the Oct Fed. Why buy for a long-term hold at 5% when the yield will likely return to 5.25-5.5% or more? Plenty of advisors are saying it’s still too soon to buy bonds. They are probably right.

Forecast

French troubles—which start with over-indebtedness—not only overflow to vulnerable economies like Italy but why not across the Atlantic, too? This is an issue that may not go away this time. The top excuse in the US is “we can grow out of it.” Well, only sort of. It would require tax reform to pay down the debt and

nobody is proposing that. Bill Clinton was the last and only president to cut the debt. Still, we will hear the growth myth upon release of the flash PMI’s later this week.

As noted above, we have several indicators validating the correction against the dollar. It’s not written in stone yet and can easily fade back to the status quo ante. We think the mover will persist, but probably not in a straight line.