“The game is afoot!"
Changes in market prices (of stocks, bonds, commodities, currencies, or anything else) are a combination of “signals” and “noise”. Noise is background chatter, reflecting random changes due to market mechanics (portfolio rebalancings, liquidations, asset allocation decisions, and the like) and technical factors (such as bid-ask spread and settlement procedures). Signals reflect true changes in value. It is very hard to decompose returns into the relevant components. Often, hearing the signal amidst the noise is impossible. This is the realm of analysts who make buy and sell recommendations by forecasting signals (driven by earnings, for example) and statistical models that attempt to isolate signals from the noise (the raison d’etre of many a “quant” hedge fund).
Sometimes a signal is so loud and clear you don’t need a model to amplify it. Such a clear signal is ignored at your own risk. The 2-year U.S. Treasury Bond yield had risen an amazing 88 basis points (0.88%) in March and on the 25th the signal became a klaxon horn as the yield rose 15 basis points, an extraordinary one-day move, flattening the yield curve (reducing the spread between short and long rates) considerably. Signals in the bond market are particularly auspicious owing to the market’s size, liquidity, and relative simplicity, acting as a sort of “canary in the coal mine” to other markets. The dead canary here is signaling that inflation is about to get even worse than we are already experiencing and that the Federal Reserve may have to be MUCH more aggressive to counter it, raising the specter of 1981-like rates, as some serious economists have recently posited. A recession is all but certain in such a scenario. We’ll see. It is often said that the yield curve has predicted 12 of the last 7 recessions, but nevertheless, no recession has ever come without the accompanying signal. The game is afoot -- we’ve been warned!
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