The sigh of relief felt in the U.S. bond market
as Congress temporarily shelved its fiscal standoff is giving way to a
more worrisome market signal: the economy isn’t as strong as we thought
it would be by now.
The Treasury market has been on a tear in recent days, beginning in
earnest as Senate leaders announced a deal Wednesday to reopen the
government through January and allow the Treasury to continue borrowing
through February. The benchmark 10-year note
10_YEAR
0.00%
yield, which falls as prices rise, is down roughly 15 basis points
from its close on Tuesday, on track for its lowest closing yield since
August. Strategists say yields are likely to stay in this range in the
near term, in contrast to the sharp yield climb that characterized much
of the summer.
“We’re pretty comfortable saying the 10-year won’t see 3% this year. At
this stage, the September yield peak will be the high of the year,” said
Ian Lyngen, senior rates strategist at CRT Capital Group.
Treasury yields, which serve as benchmark rates, push lower when
economic and political uncertainty prompt investors to buy into the
security of the government debt market. When the Congressional standoff
came to a close this week, strategists thought yields would rise as the
abating political uncertainty turned investor attention away from
Treasurys and back toward riskier assets. But yields made a U-turn and
moved in the opposite direction, catching many market participants by
surprise. It’s one sign that the debt ceiling debate had simply masked, and possibly contributed to, a slowdown in economic growth.
Before looking at the chart, let's review some bond market basics. In theory, bond prices are near their highest (and yields the lowest) right at the end of a recession. At this point in the economic cycle inflation is at its lowest and equities are offering weak capital gains potential. So, investors are looking more for the "sure thing" -- interest payments, which are more attractive because the bite of inflation is so low. As the economy expands, investors leave bonds for riskier assets, lowering bond prices and thereby increasing bond yields. One of the more difficult part of looking at the markets during this expansion has been the Fed's QE program, which have put a permanent bid in the bond market, thereby skewing the predictive power of this market action. However, with the Fed talking of tapering its QE program, one could argue we're seeing a return of the predictive power of the bond market.
The Fed began its tapering take in the late Spring, which explains the drop in the IEFs from 108.4 to 98.45, or a drop of 9%. However the bond market caught a bid during the budget showdown, printing a rounding top pattern from mid-September to mid-October. But since the end of the stand-off, bond prices printed a gap and moved higher.
The Marketwatch article continues:
“Since the end of the debt ceiling conflict, the focus has shifted in
financial markets to what the economic implications would be,” said
Jeffrey Rosenberg, chief investment strategist for fixed income at
BlackRock. “And it came at a time when the economy had been slowing
down, when there was disappointment in what was at the time heightened
expectations of better second half growth.
Rosenberg puts the turning point in economic growth around the beginning
of September, when the nonfarm-payrolls report missed expectations.
Since then, many indicators have begun to slip.
While not crashing, employment numbers haven't been printing gangbusters growth, either. As the Fed noted in its most recent Beige Book, the expansion continues to be "moderate." Durable goods have been OK as well. And now we have the fiscal drag related to the debt deal shenanigans in Washington.
This week will be the first full trading week post-debt deal. The market action should fill begin to fill in a number of gaps as the week progresses.
