On Monday, as equities sold off, the negative correlation was restored as Treasuries (NYSEARCA: TLT) rallied further:



Ok, good news, right? That is, we're getting diversification from bonds in a stock market rout.

Well, yes. But here's the problem. There are a whole lot of people out there who believe the Fed was unnerved by what it saw last week in terms of stocks rallying post-hike and the dollar dropping like a rock. That eased financial conditions markedly and essentially turned a rate hike into a rate cut. Today's action represents the reflation narrative (you know, the "Trump trade") simply rolling over and dying. Bond yields are falling, the dollar is dropping, and equities are plunging.

The 10 is at 2.43-ish. That's off the YTD lows, but remember what happened the last time yields fell and stocks were looking wobbly? Let me remind you:



Put simply, the Fed saved the reflation narrative by jawboning yields higher, and Trump saved the equity rally by sounding presidential in his first speech to Congress.

I'm not entirely sure the Fed is going to stand by and let yields continue to fall this time around either. And while it may not be overly concerned about the dollar right now (despite the fact that it's plunging), what its very well might be concerned with is this:



If bund yields continue to climb on reduced French election risk while Treasury yields continue to sink (i.e.US-German rate differentials if continue to compress), then that could send the dollar sharply lower from here.

Now that could mean one of two things. If things were to suddenly revert to some semblance of normalcy, the weaker dollar could buoy inflation and commodities. However, if the greenback continues to serve as the third leg of the reflation trinity (higher yields, higher dollar, higher stocks), then a further decline is going to be bad news for equities.

If you're following along, you can probably anticipate the next point. If the Fed moves to jawbone yields and the dollar back up, you'd better hope stocks are prepared to handle it. That is, you'd better hope that stock-bond return correlation doesn't continue to move towards positive territory.

The takeaway: I think this is a damned if you do, damned if you don't moment for equities. I cannot imagine things going well if lower yields (exacerbated by short covering on that massive Treasury short) send a risk-off signal and the dollar continues to tank. Alternatively, I am by no means sure that stocks are prepared to handle a Fed that suddenly steps in to reinforce a hawkish message just as the market wobbles.

Oh, and to all the folks still long stocks, Neel Kashkari does not have your back:

POTUS's address to the full session of Congress.... shall it be a binary outcome.... which provides additional animal spirits for the stock market and risk assets generally or be short on specifics and disappoint the voters and investors.

The administration should do the brilliant move and put tax restructuring both corporate and personal as the #1 priority and put together a package that can generate 3+ % GDP growth... 4 % would be excellent and would enable other possible things to be done later this year.

Special priority should be made to enable US companies to repatriate the Trillions of Dollars of Currency reserves held overseas. I believe the number is probably more like 4 plus trillion dollars.

If I were talking with Trump, Bannon , Wilbur Ross or Steven Mnuchin I would emphasize that congress repeat what they did in 1986. Which was a 1 time offer for US corporations to repatriate USD from overseas at a .0625% tax rate which is what they did with Reagan as President and Tip O'Neil heading Congress.

It can even be promoted as the coming together of both parties in the same way that those 2 political titans of the 1980's did in 1986. Possibly put a few stipulations that the money can not go for stock buy backs and instead be used for capital asset expansion projects.

The administration should shift priorities and make tax restructuring #1 and get it done and then move on to adjusting the ACA, which is a quagmire and the numbers are not going to add up with the added benefits of pre existing conditions and kids able to stay on parents insurance until the age of 26.