Yesterday we talked about the sharp rise in bond yields. And we talked about similar moves in yields that took place last April and last October (a year ago).
In both cases, the catalyst was an escalation of the war in the Middle East, which raised the specter of global war.
Why would yields rise? Because in a wartime scenario, the government would respond with (a lot) more spending. And the debt problem would multiply.
And with that, the Fed would likely facilitate a wartime fiscal expansion, by a return to "extraordinary measures."
How did the Fed do it in World War 2? Yield curve control.
They financed war debt by pegging short term rates at a fixed rate, and by capping rates on longer term Treasuries.
As for the Fed's current policy path: The Fed is now dealing with an interest rate market that has reversed its September 50 basis point rate cut. The 2-year yield was 3.60% on September 18th. Today it traded as high as 4.08%.
And remember, it was the sharp move higher in bond yields a year ago (last October) that led Jerome Powell to signal the end of the tightening cycle, citing the tightening of financial conditions that had taken place in bond yields.
That was the top in yields (at 5% in the 10-year).
And it came in a bond market where speculators were net short treasury futures (i.e. betting on higher yields) at record levels.
Such extremes in market position tend to be contrarian indicators.
Indeed, those bets against bond prices last October were wrong. It was the turning point for the interest rate market.
Guess what? The net short position in treasury futures is even more extreme short right now (chart below).