The bond market usually runs in the background in people’s minds, with most only paying attention when yields are wavering one way or the other. More recently, yields have mostly dipped lower as the consensus called for them to rise. This was enough to grab the attention of investors.
Recall that the yield on 10-year treasury bills was supposed to be heading towards 2% this year, more than double where it ended 2020, in a context of continued reopening of the economy, made possible by the introduction of vaccines against Covid-19 and the push provided by monetary and fiscal stimulus measures on an unprecedented scale.
But after approaching the 1.75% mark at the end of the first quarter, the key benchmark yield largely beat those expectations by reversing and falling. On Thursday, the 10-year rate was close to 1.25%, its lowest level since February. Even outside the confines of the bond market, this raises a question: what is wrong with this picture?
After all, the economy has been booming, accompanied by rising inflation, the exact opposite of what would be conducive to lower yields and higher prices. According to consensus estimates by economists, US gross domestic product grew at an annual rate of 9.6%. The predictions were accompanied by a parade of anecdotes about house price bubbles and shortages of used cars, as well as workers. At the same time, the main stock market indices were hitting or approaching records.
Still, the bond market didn’t seem to get the message. A month ago, this column claimed that the market seemed to be looking more towards the future. Yields rose sharply at the start of the year, ahead of the current strong economic gains. But the bond market is now adjusting to the prospect of more moderate growth in the second half of the year, with reduced budget largesse and no stimulus checks of $ 1,400 or $ 600. And he anticipates the possible prospect of the Federal Reserve slowing its purchases of securities, which currently inject $ 120 billion per month into the financial system.
And as yields slumped and bonds rallied, stocks retreated towards the middle of the week for fear of the debt market message. But after the 10-year keynote rebounded from the psychological support level of 1.25% early Thursday, which also coincided with the 200-day moving average of the benchmark yield, stocks retreated from their funk. At the end of the shortened vacation week, the
Dow Jones industrial average,
index, and the
hit record highs, with gains of around 1% on average, while the yield on the 10-year note stood at 1.35%.
Looking ahead to the week ahead, investors returning from an extended Independence Day hiatus will be faced with a plethora of key economic data, important testimony from Congress President Jerome Powell, and the start of second quarter earnings season.
Figures on the economy suggest that the booming second quarter ended with a stagflationary whimper. On the inflation side, consumer prices would have increased by 0.5% in June, against 0.6% in May, and are 5% above the level of the previous year, just like the previous month. Retail sales are estimated to have fallen 0.6% in June, on top of a 1.3% drop in May, largely due to lower auto sales. The latter could reflect tight supplies of certain models, due to shortages of semiconductor chips. However, there are signs that the used car market is boiling. Nomura economists note a 1.3% drop in the Mannheim used car index last month.
Powell will likely be asked (by the House Financial Service Committee on Wednesday and the Senate Banking Panel on Thursday) how the Fed sees the economy growing, particularly on jobs. His prepared testimony, released Friday, discusses the gap between job vacancies – a record 9.21 million in May, according to the latest Jolts (Job Openings and Labor Turnover Survey) – and unemployment, which has soared. at 5.9% in June. There is little that monetary policy can do to address this mismatch other than to keep the economy running, risking further inflationary pressures and market distortions.
Market participants are hoping Powell’s Inquisitors question him about the impact of the Fed’s pending securities purchases on bonds, stocks and housing.
On the last point, even some Fed officials have started to wonder when to cut the $ 40 billion in agency mortgage-backed securities that the central bank buys each month amid a housing boom. Most Fed watchers don’t see a drop in mortgage or treasury purchases until next year. The statement prepared by Powell reiterates that before the Fed cuts back on buying, it will give sufficient notice to avoid disrupting markets.
The Fed isn’t the only central bank to watch. The People’s Bank of China eased monetary policy on Friday. After the Asian markets closed, he announced a larger-than-expected 0.5% reduction in banks’ reserve requirement ratios, freeing up one trillion yuan ($ 154 billion) in cash.
Bank of America‘s
The strategy team, led by Michael Hartnett, notes that spreads on Chinese high yield bonds have increased sharply (by three percentage points, to reach 11 percentage points, a sign of credit strains) over the past six years. last few weeks. This was accompanied by a collapse in large-cap Chinese tech stocks. Lower bond yields are not bullish if accompanied by wider spreads, they stress. The PBOC’s measures appear to ease this credit distress, which has also affected Chinese real estate.
On both sides of the globe, central banks and interest rates remain essential for markets.
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Write to Randall W. Forsyth at email@example.com