Make Way for The Gods of the Copybook Headings, Terror and Slaughter Could Return in 2022

Back in November I posted Don't Be Surprised by a Crash. I posted this chart of Vanguard Short Term Bond (BSV):

I took my eye off it, but it completed in early January:

There's nothing particular about this fund. I haven't looked at every chart, but I assume all of the short-term bond funds have the same topping pattern. Some look particularly ugly, such as the MUB chart I posted yesterday.

With bond funds, it is important to look at the funds without dividends such as the futures contracts or the interest rate charts. Here is BSV with the dividends taken out.

There is about 1 percent downside to the $79.50 target on BSV, but the larger target is the $78 level (2.8 percent below Friday's close) from 2018 that is associated with a 3-percent yield on the 2-year Treasury (BSV has a duration of 2.75).

Anyone who has been reading this blog knows I lean in the disinflationary/deflationist camp. As happened in 2008, 2011, 2014-2016, 2018 and 2020, commodities will roll over, long-term bonds will rally, stocks will plummet and the Federal Reserve will pump one more time. Looking at the chart above, maybe the 2-year Treasury peaks out at 1 percent here, or around 1.5 percent later this year, and then goes negative in the next downturn.

And yet, there's going to be a time when this doesn't happen. That is the moment when terror and slaughter return to the stock market because it means the Federal Reserve is at the mercy of the bond market.

What will this moment look like? It'll go something like this. The markets will be tanking and bonds will be rallying, but not as strong as in prior downturns. Maybe commodities fall too, but they might be outperforming stocks. Then the Fed will announce its rescue package. It could happen immediately or months later (my hunch is sooner rather than later), but traders will funnel the Fed's pump into commodities instead of stocks. Crude oil will surge higher. Bond traders will eventually react by selling bonds down. BSV, as one example, will crash right through that $78 level. The 2-year treasury will have broken through 3 percent on massive volumes. The 10-year will be through 4 percent. 

At some point, the stock market will realize what is happening. It will know the Fed not only has to reverse QE, but it also has to begin emergency rate hikes and maybe start dumping bonds. Like Volcker in the early 1980s, the Fed will have to front run the bond vigilantes. If this all happened in a few days, stocks could experience a 20-percent limit-down day that closes the stock market early, maybe right after the first opening trade. If it plays out over weeks and months, there will be periods of relentless selling, bounces, and then resumption of selling as soon as crude oil and interest rates make a new high.

I don't believe this is the highest probability outcome this time, but the purpose of the charts is to tell me both when I'm right and wrong. The 2-year treasury yield should not clear 3 percent and should reverse much sooner. Crude oil should repeat the taper pattern:

If I'm "wrong", crude oil isn't going down. The end game for the Federal Reserve has arrived. I put wrong in quotes because what is really wrong is losing money. It doesn't matter if your thesis is wrong, as long as you have a falsifiable thesis. What makes your outlook wrong? For me, it will be rising crude oil and interest rates beyond resistance. Rising stocks would count too, but that is a separate scenario. I would be totally off base if stocks rise, bond yields rise and crude falls, or if all three rise without causing any negative shocks.

As for how bad things will get if the Federal Reserve has met the end game, the answer is extremely bad for the entire society. It's not going to be solely an economic event. It will be the crisis phase of what is commonly dubbed the 4th Turning. Turchin, Prechter, pick your favorite. Many people like myself have lost whatever remaining trust we had in institutions following the coronavirus scamdemic, including losing trust in doctors and teachers. The people who trust the government, who trust the Federal Reserve, are going to be wiped out when this crisis hits. America is led by its most corrupt, malicious and incompetent people. The corrupt and malicious are at the top, with the incompetents providing the buffer layer between them and the public. The government asnd Fed willl curse anyone associated with them. If I was running a pension fund and could not go short or substantially shift my allocations, for example if I was banned from buying oil because of ESG rules, I would resign. When the collapse comes, the public won't understand that you were a fool for taking the job at all, and weren't actually the one responsible for the losses. Von Mises correctly turned down the job of central bank president in Austria and fled to America. We could be at that level of crisis if inflation doesn't reverse.