The Bond Market Is Not the Economy, Just Traders’ Bets on It
(Bloomberg Opinion) -- Repeat after me: The bond market is not a foolproof reading of the U.S. economic outlook.
Every once in a while, Treasuries steal the spotlight from stocks. Last week was certainly such a time: The benchmark 10-year yield plunged to 2.13%, the lowest since 2017; two- and five-year yields easily broke through the psychological 2% mark; and the long bond retraced its entire move since Donald Trump was elected president. Trump, of course, sent markets into a risk-off tizzy after vowing to impose tariffs on all Mexican goods over illegal immigration, adding a second front to America’s trade war and raising the prospect of weaker domestic growth.
Strategists at JPMorgan Chase & Co. and NatWest Markets were among those who wasted little time in forecasting two quarter-point rate cuts from the Federal Reserve by the end of the year. Barclays Plc went so far as to call for a 75-basis-point reduction by the end of 2019, with chief U.S. economist Michael Gapen noting that Treasuries have done an “apparent repricing of the outlook for global growth.”
I’m not here to suggest that slapping tariffs on Mexico based on vague conditions, when the two countries already had a trade deal in place, is a good thing. It’s clearly not. My Bloomberg Opinion colleagues have already shown American consumers will be hit the hardest, which could further strain retailers, while manufacturers are mired in supply-chain uncertainty.
Instead, I will point out that in the wake of this bombshell policy shift, Minneapolis Fed President Neel Kashkari insisted he’s “not quite there yet” on the need for a Fed interest-rate cut. How can that be? After all, bond traders are pricing in three cuts by the end of 2020. These words — from one of the more dovish policy makers — are worth heeding:
“I take a lot of comfort from the fact that the job market continues to be strong. I want to see that continue. But, we have to wait and see. We have to see how the data comes in."
“Let’s keep watching the job market. If the U.S. economy continues to create 200,000 jobs a month on average that’s a strong job market.”
On its face, this is merely the same old data dependency and laser focus on the central bank’s dual mandate. But it’s also a reminder that Treasury yields shouldn’t be viewed as a perfect assessment of the U.S. economic picture. The argument that a low 10-year yield is ominous for risk assets, for example, is not quite the correct causal relationship. In fact, low interest rates are typically a boon to stocks and weaker corporate debt. It comes down to the reason yields are falling. If it’s because the economy is worse than expected, then stock investors are right to worry. If bond traders are merely trying to get ahead of a slowdown, the decision is less clear.
To Kashkari’s point, the U.S. labor market is humming along. A Labor Department report on Friday is expected to show American companies added 180,000 workers in May, keeping the rolling 12-month average in line with his expectations. This week also brings other crucial data points: A key gauge of U.S. manufacturing on Monday; April factory orders and durable goods orders on Tuesday; Markit’s services and composite purchasing managers’ indexes on Wednesday; first-quarter productivity and unit labor costs on Thursday; and, of course, the jobs report on Friday.
Despite all the doom and gloom, Citigroup Inc.’s U.S. Economic Surprise Index is close to the highest level since February. Granted, it was near a two-year low just a few weeks ago, but it nonetheless shows everything isn’t spiraling downward — at least not yet.
To be fair, bond traders don’t get paid to look backward. If the Fed does wind up cutting interest rates three times before the end of the year, from the current range of 2.25%-2.5% to 1.5%-1.75%, then buying a two-year Treasury note around 2% looks like good value. Particularly if you expect policy makers will continue dropping rates into 2020. And the deeply inverted yield curve has been as good a predictor as any of an eventual recession.
For a variety of reasons, though, the Fed is reluctant to move from its current policy. For one, the U.S. economy is clearly still expanding. Officials would also prefer to avoid the appearance of being overly influenced by the bond market or the president. And, crucially, it’s early days in this self-inflicted, two-front trade battle. How exactly will companies deal with supply-chain disruptions? How much of the extra cost will be passed along to consumers, and how will that show up in inflation data? Will those same consumers, who apparently feel as good about current economic conditions as they have in 18 years, even change their behavior all that much?
There’s no way to know for sure, but bond traders, by their nature, are preparing for the worst. I called it “panic buying” last week, or loading up on Treasuries, regardless of price, and sorting out positions when the dust settles. Some market observers were especially struck by the lack of sellers as yields set new lows. Even DoubleLine’s Jeffrey Gundlach, who has been adept at pinpointing crucial levels in recent years, may wind up being premature in tweeting on May 29 that long-maturity Treasury prices looked “consistent with a blowoff momentum top.” He expected “buyer’s remorse will set in fairly soon.”
So far, there are no regrets. That could change if economic data proves resilient, giving the Fed enough reason to stand firm at its meeting this month in the face of mounting risks.
In the end, the bond market is a way to aggregate informed opinions on the direction of the U.S. economy. Right now, the consensus is for a worsening outlook. That may very well come to pass, but not simply because Treasuries say so. Fixed-income traders are smart, but they’re not omniscient. Trump has weaponized tariffs to a new extreme. Give the world’s largest economy the chance to prove it can withstand them better than investors anticipate.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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