Happy Valentine’s Day from your Hometown Lender,

The bonds market has been surprisingly strong this week despite much stronger than anticipated inflation data. Why? Well, 1) Mr. Powell commented that one or two strong reports wont derail the Fed, 2) Reciprocal tariffs are sounding more benign and less scary than were expected, and 3) Retail sales numbers were horrible. Really horrible, and would lead you down the path that inflation cannot rise if no one is buying goods.

Here are two pieces that are very interesting on the markets. The first from Bloomberg and the second from the WSJ. Worth the read although maybe not on Valentine’s Day. Save it for later 😊.

Bloomberg:

The year is still young but moves on Wall Street this week point to a couple of important trends to keep an eye on.

1. Reliable market patterns are hard to come by in the Trump era — especially as inflation anxiety comes back. 
2. Stocks and bonds remain stubbornly correlated at times, prompting traditional money managers to consider fresh diversification strategies.
3. The buy-and-hold passive crowd are in fighting spirits. 

On point 1: Just look at recent moves in the world’s largest bond market. An exchange-traded fund tracking long-dated Treasuries (ticker TLT) dropped more than 1% after Wednesday’s dispiriting inflation report, before staging a rally in the largest back-to-back reversal since November. In the equity market, technology shares have reclaimed the top spot in the leaderboard this week, after becoming the only loser out of 11 major industries earlier in the year.

Blame the whiplash in large part on Trump’s volatility-inducing policy agenda — tariffs, deregulation, tax cuts, federal worker buyouts, and so on — which threatens an otherwise stable economic backdrop.

Adding to the recent confusion is worrisome inflation data. Treasury yields spiked and stocks retreated on Wednesday as hotter-than-expected consumer prices cast doubt on imminent rate cuts. Yet both stocks and bonds reversed course Thursday, as traders brushed aside a strong reading in the producer price index and took comfort in the weakness in several of its components.

Still, there are few signs of fear, at least judged by the action in the options market. The Cboe Volatility Index, a gauge of costs on S&P 500 options, has fallen this week, hovering near its January lows. The ICE BofA MOVE Index, a similar measure for stress in fixed income, also retreated, touching a two-month low. That sense of security can be justified by the fact that both bonds and stocks have managed to stay green year-to-date.

2. The problem for Wall Street, though, is the stubborn tendency of stocks and bonds to move together in recent weeks. Investors should take this lesson to heart and remember 2022’s inflation-induced cross-asset selloff, according to Kevin Kinzie, chief executive officer at LoCorr Funds.

“If the equity markets go down 10% or 15%, you’re going to see similar movement in fixed income,” he said. “The whole portfolio is going down. You’re not diversifying it.”

Instead of seeking a haven in bonds, a better option would be adding a cohort of strategies that have historically shown low correlation to stocks, such as trend following, he said. That’s exactly what the firm’s newly launched LoCorr Strategic Allocation Fund does by combining tax-managed equities and multi-manager futures strategies.

3. The good news: For all the confusing market patterns of late, passive funds – which have gobbled up trillions of investment dollars in recent years – look poised to shine again. A notable fact of the latest turbulence is the re-emergence of themes that tend to benefit these index-hugging managers over their stock-picking brethren. They include growth stocks far outpacing value equities, small caps going nowhere, and the market-weighted S&P 500 pummeling its equal-weight version.

Each of those moves represented an interruption in trends that before Monday had shown signs of lifting the fortunes of active managers. For investors who keep shoveling billions of dollars into S&P 500 and Nasdaq 100 ETFs, it’s a reason to cheer.

And from the WSJ:

Tomorrow two U.S. Treasury notes will mature and their owners will receive $145 billion, plus a bit of interest.

That sure sounds like a lot of money, and it would be for anyone other than the federal government, but bills, notes and bonds get refinanced all the time: Around $9 trillion will have to be issued to repay existing ones this year alone.

They’ll find buyers at the right price. Compare old and new debt, though, and one gets the feeling the boring bond market might one day become a bigger worry for stocks than DeepSeek and tariffs combined. Saturday’s maturing notes were issued in 2015 and 2022 at 2% and 1.5% interest rates, respectively. And you were impressed with yourself for locking in that cheap mortgage!

Treasury Secretary Scott Bessent has said he wants to rely less on short-term bills and to sell more notes—debt that matures in between two and 10 years.

Unfortunately the market has demanded higher rates on benchmark 10-year notes since the Fed started easing five months ago, surprising many economists. Rates are complicated, but the simplest and most-disturbing explanation is that buyers are just a tiny bit worried about getting repaid.

Not about an actual default—the U.S. borrows in dollars and owns a printing press. But what if the Fed is forced to crank it up one day just to help keep borrowings manageable? That could make the dollars that bondholders are promised less-valuable. This week a market measure of expected inflation over the coming decade, known as a breakeven, hit its highest since October 2023.

The Congressional Budget Office forecasts a deficit this fiscal year of almost $2 trillion. It’s seen falling in 2026, but mostly because the CBO assumes Trump’s 2017 tax cuts will expire (unlikely) and that average interest rates on government debt will drop to 3.3%, hovering near there for years.

Maybe that’s the prevailing rate in The Republic of Fantasylandia, but United States Treasurys yield between 4.3% and 4.8%. Like those expiring Saturday, most outstanding notes were sold at rates lower than that—less than 3% on average.

Forecasts are hard: Today’s net national debt is 43% higher than the CBO foresaw a decade ago despite that stretch of super-low interest rates. In fairness, its hands are tied—CBO’s long-term projections assume tax cuts sunset on schedule and can’t foresee pandemics or recessions.

Even without some cataclysm, though, selling trillions in new Treasurys is getting expensive. Just the interest on existing debt is now more than all non-defense discretionary spending combined.

You don’t have to own bonds or be shopping for a mortgage to be at least a little concerned: Treasury yields help determine corporate borrowing costs and they set the “risk-free” floor below which stocks look unattractive. With stocks’ price-to-earnings ratio already high, the extra return for owning equities has narrowed.

If normally humdrum Treasury auctions start drawing attention outside bond trading desks then it won’t be a good sign for taxpayers or investors.

Stay safe, enjoy the holiday weekend, and first make Valentine’s Day great!!!