A shopper in a Trader Joe’s market during the height of the pandemic, when the current economic boom was unexpectedly building in the U.S.
Jeffrey Isaac Greenberg/Alamy
The bond market typically operates in the background in peoples’ minds, with most taking notice only when yields lurch in one direction or another. More recently, yields have mainly zagged lower when the consensus call was for them to zig higher. That has been enough to grab investors’ attention.
Recall that the 10-year Treasury note yield was thought certain to be headed to 2% this year, more than double where it ended 2020, amid the economy’s continued reopening, permitted by the introduction of the vaccines against Covid-19 and the thrust provided by unprecedentedly large monetary and fiscal stimulus.
But after nearing the 1.75% mark at the end of the first quarter, the key benchmark yield has largely confounded those expectations by reversing course and moving lower. On Thursday, the 10-year yield skirted 1.25%, its lowest level since February. Even outside the bounds of the bond market, this raises a question: What’s wrong with this picture?
After all, the economy has been booming, accompanied by rising inflation—exactly the opposite of what would be conducive to lower yields and higher prices. Consensus estimates among economists had the U.S. gross domestic product zooming ahead at a 9.6% annual clip. The predictions have been accompanied by a parade of anecdotes about bubbles in house prices and tight supplies of used automobiles, as well as of workers. At the same time, the major stock market indexes were hitting or hovering near records.
Yet the bond market didn’t seem to get the message. A month ago, this column argued that the market instead seemed to be looking ahead. Yields rose sharply early in the year, before the current robust economic gains. But the bond market now is adjusting to the prospect of more moderate growth in the second half, with reduced fiscal largess and no $1,400 or $600 stimulus checks. And it’s looking ahead to the eventual prospect of the Federal Reserve throttling back its securities purchases, which currently pump $120 billion a month into the financial system.
And as yields slumped and bonds rallied, stocks backed off around midweek out of concern of the message of the debt market. But after the key 10-year note bounced off the 1.25% psychological support level early on Thursday, which also coincided with the 200-day moving average for the benchmark yield, stocks pulled out of their funk. By the end of the holiday-shortened week, the Dow Jones Industrial Average, the S&P 500 index, and the Nasdaq Composite stood at records, with gains averaging about 1%, while the 10-year note’s yield wound up at 1.35%.
Looking ahead to the coming week, investors returning from an extended Independence Day break will confront a slew of key economic data, important congressional testimony by Federal Reserve Chairman Jerome Powell, and the beginning of the second-quarter earnings-reporting season.
The numbers on the economy will suggest that the booming second quarter ended with a stagflationary whimper. On the inflation front, consumer prices are forecast to have risen 0.5% in June, versus 0.6% in May, and to have come in 5% above the level a year earlier, just as the preceding month did. Retail sales are estimated to have fallen 0.6% in June, on top of May’s 1.3% drop, largely a result of lower auto sales. The latter might reflect tight supplies of some models, owing to semiconductor chip shortages. However, there are signs that the used-car market is coming off the boil. Nomura economists note a 1.3% drop in the Mannheim Index of used cars last month.
Powell is likely to be quizzed (by the House Financial Service Committee on Wednesday and the Senate banking panel on Thursday) on how the Fed sees the economy progressing, especially on employment. His prepared testimony, released on Friday, addresses the gap between job openings—a record 9.21 million in May, according to the latest Jolts (Job Openings and Labor Turnover Survey)—and unemployment, which ticked up to 5.9% in June. There’s little that monetary policy can do about that mismatch, other than to continue to let the economy run hot, risking further inflationary pressures and market distortions.
Market participants hope that Powell’s inquisitors ask him about the impact that the Fed’s ongoing securities purchases are having on bonds, stocks, and housing.
On the last score, even some Fed officials have started talking about when to reduce the $40 billion of agency mortgage-backed securities that the central bank buys every month in the midst of a housing boom. Most Fed watchers don’t see lower purchases of mortgage or Treasury securities until next year. Powell’s prepared statement reiterates that, before the Fed does trim its buying, it will give ample notice to avoid upsetting the markets.
The Fed isn’t the only central bank to watch. The Peoples Bank of China eased its monetary policy on Friday. After Asian markets had closed, it announced a larger-than-expected 0.5% reduction in banks’ required reserve ratios, effectively freeing up one trillion yuan ($154 billion) of liquidity.
Bank of America’s strategy team, led by Michael Hartnett, notes that spreads on Chinese high-yield bonds have gapped up sharply (by three percentage points, to a yawning 11 percentage points, a sign of credit stresses) in the past six weeks. That has been accompanied by a slump in Chinese large-cap technology stocks. Lower bond yields aren’t bullish if they’re accompanied by wider spreads, they point out. The PBOC moves would seem to ameliorate that credit distress, which has also hit Chinese real estate.
On either side of the globe, central banks and interest rates remain key to markets.
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Write to Randall W. Forsyth at [email protected]
