The Daily Prophet: Bond Traders Have No Time for Fair Value
(Bloomberg View) -- The market for U.S. Treasuries, often called the most important market in the world, had a terrible January. Losses totaled 1.36 percent, the worst start to a year since 2009 as measured by the Bloomberg Barclays U.S. Treasury Index. February isn't starting off too hot, either.
The price of the benchmark 10-year note fell again on Thursday, pushing its yield to as high as 2.79 percent, up from 2.40 percent at the end of December. The jump foreshadows higher borrowing costs for the government just as it looks to step up debt sales to pay for an expanding budget deficit. It will also affect companies and consumers. It's safe to say that the jump in yields has taken most by surprise. In fact, yields weren't supposed to get this high until sometime in the third quarter, according to a Bloomberg News survey of more than 60 economists and strategists conducted between Jan. 5 and Jan. 11. The move is troubling because in many ways low yields and a stable bond market have underpinned the recent period of low volatility across all markets. But if that's going away, then markets look less stable.
"Each day's retreat from the range-ish, lower volatility world of 2017 has investors more convinced lower bond prices are penance for previously benign conditions," Jim Vogel, an interest-rate strategist at FTN Financial, wrote in a research note. "The breakdown in order, of course, should have investors less confident they know where rates are headed. But, that's not how markets function. Without technical guidance tethered to fundamentals, the power of charts is magnified and ideas of 'fair value' sift to the bottom of the pile."
STOCKS DEVELOP AN UNNERVING TREND
After the gut-wrenching declines on Monday and Tuesday, the S&P 500 Index started out strong on Wednesday, only to erase those gains to end little changed on the day. The gauge was up nicely again Thursday, rising as much as 0.43 percent, but also fell back to little changed as bond yields rose. The struggles come even though the outlook for earnings growth is improving. Over the last four weeks, 2018 per-share profit estimates have climbed 4.5 percent, which is about nine times the average monthly pace of the past five years, according to Bloomberg Intelligence's equity strategists. Perhaps stock traders are worried about rising borrowing costs crimping profitability. Or, maybe they are worried that strong earnings growth isn't enough to make up for the current nosebleed-like valuations. Or, maybe the fact that stocks have stabilized in teh face of higher bond yields is a sign of resilience. "Strong global fundamentals may offer an opportunity to use potential pullbacks as a chance to add to portfolio positions," John Lynch, the chief investment strategist at LPL Financial, and Ryan Detrick, the firm's senior market strategist, wrote in a research note.
WHERE'S THE BOTTOM?
The dollar picked up where it left off in January, which is to say that it weakened yet again. After tumbling 3.43 percent last month in its worst performance since March 2016, the Bloomberg Dollar Spot Index started February by dropping as much as 0.49 percent. Currency traders just don't see many reasons to buy the dollar with the Trump administration seen as wanting a weaker currency to help close the growing trade deficit and with the U.S poised to ramp up borrowing to pay for an expanding budget deficit. Against the euro, the dollar has weakened from $1.2005 at the end of December, to $1.2522 on Thursday, and Goldman Sachs just revised its estimates and now sees it heading to $1.30. As Pacific Investment Management Co. put it, the greenback’s almost 12 percent plunge since the start of 2017 is being fueled by fiscal and monetary policies as well as rhetoric intended to debase the U.S. currency. “These actions are sending an implicit but very clear signal to markets: A weaker dollar is the goal," Pimco global economic adviser Joachim Fels wrote in a blog post. "Markets have understood the signal.”
WHAT BEAR MARKET IN BONDS?
With central banks turning more hawkish -- or at least less dovish -- and inflation starting to stir, it seems like everyone is talking about the end of the three-decade-long bull market in bonds. While U.S. Treasuries may have suffered, the reality is that the global debt market turned in a strong performance in January. The Bloomberg Barclays Global Aggregate Bond Index rose 1.19 percent in its biggest monthly gain since July. Thank China. The Bloomberg Barclays China Aggregate Index soared 3.56 percent, the most since that index was created in 2004. Much of that return, of course, comes from the relatively high yields offered on Chinese bonds after a nasty selloff late last year. But the fact China's market for fixed-income assets, which is one of the biggest in the world, stabilized last month should be a good sign for debt investors. Chinese came into the year with a renewed focus on deleveraging, introducing new curbs on leveraged trading in the bond market and zeroing in on small banks’ reliance on short-term debt, according to Bloomberg News.
GOLDMAN'S HIGH ON COMMODITIES
Goldman Sachs had a terrible time with commodities in 2017, with revenue dropping in this area of its business by 75 percent. This year should be a whole lot better, if the firm's strategists are to be believed. They are more bullish on commodities than any time since the end of the supercycle in 2008, according to Bloomberg News' Mark Barton. As economies around the world pick up, factories are humming, eating into stockpiles of raw materials and driving demand at miners and oil producers already facing limits on output. Copper, iron ore and crude prices will extend gains this year, Goldman Sachs analysts Jeffrey Currie and Michael Hinds said. “The environment for investing in commodities is the best since 2004-2008,” they wrote in a research note. Rising commodity prices will create a virtuous circle, improving the balance sheets of producers and lenders, and expanding credit in emerging markets, which will, in turn, reinforce global economic growth, according to the bank. The bullish outlook for commodities comes as European factories boost output to near-record levels and Goldman says its gauge of U.S. financial conditions is the strongest ever.
Get ready for a sub-4 percent U.S. unemployment rate. It may not happen Friday when the government releases its monthly jobs report, but it is coming sooner rather than later, a growing number of economists say. That's apparent after the ADP Research Institute said on Wednesday that employers added 234,000 jobs in January, a sign of a hot jobs market. According to Bloomberg Economics, that raised the likelihood that the unemployment rate drops below 4 percent for the first time since 2000 ``in just a few months." The government on Friday is forecast to say the economy added 180,000 jobs last month, leaving the unemployment rate at 4.1 percent. As usual, investors will be closely watching what happened to salaries for clues to whether inflation is accelerating. The median estimate of economists surveyed by Bloomberg is for an increase of 0.2 percent average hourly earnings, down from 0.3 percent in December.
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This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Robert Burgess is editor of Bloomberg Prophets.
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