Black swan in bonds puts Fed on notice

Published Sun, Feb 22 20154:38 PM ESTUpdated Mon, Feb 23 20157:26 AM EST

Last week the bond market did something it's only done one other time in 45 years. Yet not many people noticed. Last Tuesday before the release of the Federal Reserve minutes, the yield on the 10-year Treasury completed a move that took it from 1.64 percent on Jan. 30 to 2.14 percent in just 10 trading days. The nearly 30 percent increase was the second-biggest 10-day move in the yield since 1970. Only an increase in January 2009 as the economy moved out of the financial crisis had that kind of magnitude in that short of a period, according to technical analyst Chris Kimble of Kimble Charting Solutions, who first put the gravity of this move into perspective in a note to clients. Kimble wasn't the only one who noticed the extremity of this move. " This is a screaming buy" for bonds, said Larry McDonald, head of U.S. strategy, macro group, Societe Generale. He sent a note to clients last week saying buy bonds as there's no way rates should move in a straight line higher like they have. (Bond prices move inversely to yields.) And McDonald noted the rising rates have put the Federal Reserve on notice on what will happen when it starts talking hawkish and hints at a rate increase this year. In the wake of an unprecedented quantitative easing action, the central bank should think twice about raising its benchmark rate when the market clearly isn't ready, evidenced by the rapid move higher in yields, McDonald said. Read More These stocks are the sweet spot for the market " What a lot of economists are getting wrong is they're missing the political side of the Fed," said McDonald. "You can't use the Phillips Curve methodology this time around as a technical reason to raise rates. What the Fed is most worried about now is the rise in the dollar, Greece, and a China slowdown. Not so much the traditional levels of unemployment and risk-free rates." After a jump in bond prices and fall in yields in McDonald's favor following the Wednesday release of the dovish Fed minutes, rates reversed and headed higher again to end the week so there is still time to get in on his capitulation trade. " The Fed was — and surely still is — concerned about the bond market's reaction," wrote Dan Greenhaus, chief strategist at BTIG LLC in a Wednesday note to clients. Central bank Chair Janet Yellen testifies before Congress Tuesday and Wednesday and investors said to expect more dovish discussion to walk back this move in rates. After hawkish talk by Fed members over the last month, market expectations for a rate hike by the central bank have moved back up to June. The Money Play: So if McDonald is right and bond yields are set to move lower and bond prices to rise, what should one buy? Many point to a popular ETF tracking the long end of the bond curve, the iShares 20+ Year Treasury Bond fund . If the equity market is your game, CNBC.com surfaced some stocks using Kensho that rise when bond yields fall. We looked at the six times since 2005 when long-term interest rates pulled back by at least 5 percent and which stocks in the S & P 500 and which sector ETFs did best 30 days later. The list of ETFs should confirm theories one may have about what happens when rates fall. Consumer shares ride the easy borrowing. Tech shares enjoy the lower borrowing costs and a drop in the dollar. And utilities see gains as their dividend payouts suddenly get more attractive versus bond yields. The SPDR Consumer Discretionary , the SPDR Technology and the SPDR Health Care , on average, posted a rise of about 5 percent in the 30 days after a rate spike. SPDR Utilities gained 4 percent. Refiner Tesoro Petroleum was the top-performing stock jumping more than 30 percent in the monthlong period following rates shooting higher. Home builder Lennar climbed 24 percent on average. Bond-ratings firm McGraw Hill typically rose 22 percent and Investment firm Affiliated Managers Group posted a 21 percent jump. To be sure, the turnaround in rates could be a long-term move, ending a 30-year downdraft. " If the Fed actually hikes around midyear and investors begin to think that the terminal rate is around 3 percent or higher (as I believe), then long-term interest rates have not bottomed and will trend higher (possibly significantly so)," said Joe Lavorgna, Deutsche Bank economist. Disclosure: NBCUniversal, parent of CNBC, is a minority investor in Kensho.

Janet Yellen, Chair of the Federal Reserve.

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Last week the bond market did something it's only done one other time in 45 years. Yet not many people noticed.