Wake Me When the Bond Market Breaks: Chief's Guide to Yields and Global Risk

Bonds: Not Just for Covenant Anymore

Alright Marines listen up! We're diving into bond yields. Sounds boring I know but trust me these numbers can tell us more about the economy than a Grunt can about its plasma grenade. Higher yields? Could mean things are picking up. Lower yields? Could mean we're heading for a crash landing. Remember Reach? Yeah nobody wants that. Bond yields act as a critical insight into economic expectations inflation and currency valuation and can affect consumers (who like stronger currency) and producers/exporters (who prefer a weaker currency).

Inflation: The Real Energy Sword

Inflation: it’s like a crazed Elite with an Energy Sword. It can slice and dice your purchasing power faster than you can say 'wort wort wort.' Bond yields factor in inflation forecasts. If yields are rising because of inflation investors want to be compensated or their investments could go the way of Installation 04. Higher yields indicate rising inflation expectations as investors demand compensation for eroding purchasing power. In theory investors can distinguish whether yields are increasing due to better economic expectations or worse inflation expectations by observing the spread between nominal yields and inflation protected securities (TIPS).

Currency Wars: More Than Just Brute Force

Currency valuation is like trying to predict where a Hunter is going to charge. Tricky but crucial. Higher yields usually boost a currency's value. Think of it as your shield recharging faster. But lower yields? That's like getting EMP'd by the Flood. Your currency is vulnerable. Lower yields reduce a currency's appeal potentially weakening it against other currencies especially if other central banks offer higher rates. These yield differentials are key drivers in carry trades.

The Yen Carry Trade: A Potential Plasma Grenade?

The spread between Japanese and U.S. Treasury rates began to narrow in early 2024 which prompted concerns about substantial deleveraging as investors worried about an unwinding of the yen carry trade. It’s like setting up a chain reaction of plasma grenades hoping it works out. Remember what happened when Cortana got a bit unstable? Yeah nobody wants that on a global scale. If Japanese rates rise more quickly than US rates this is problematic because it might pressure the carry trade and the amounts involved are substantial.

Japan's Debt: Bigger Than a Scarab

Japan is even more indebted than the U.S. due to the size of its economy roughly 250% of Japan's GDP with total government debt of approximately $8 trillion. That’s a lot of zeroes. We're talking 'Halo ring' levels of debt. If the spread does not compress then that suggests U.S. Treasury rates would also rise which could pressure other risk assets. If Japanese rates continue to increase this presents a global risk.

Time to Hedge: Lock and Load

The S & P 500 has clawed back more than 70% of its peak to trough losses from the all time highs in February and the Cboe Volatility Index (VIX) although elevated is well off the April peak. For these reasons I think re initiating hedges might be advisable. For example a June 30th (month ending) SPDR S & P 500 ETF Trust (SPY) 575/525 put spread ($50 wide) cost ~ $8.90 per contract or just over 1.5% of the current share price of the ETF and less than 18% of the difference between the strikes offering a payoff of better than 4.5:1. The trade: Buy SPY June 30 $575 put Sell SPY June 30 $525 put. Time to be proactive. Lock and load Marines. We've got a market to watch.