The U.S. bond market took it on the chin again last week. The question is: Was this is a harbinger of even higher yields to come or just an overreaction to some potentially scary headlines – some of which turned out to be fake news – and therefore a potential buying opportunity?
“Bond King” Bill Gross started the fun on Tuesday when he tweeted out these ominous words: “Bond bear market confirmed.” He did tone that down in his market commentary to his Janus Henderson clients, saying, “We have begun a bear market although not a dangerous one for bond investors. Annual returns should still likely be positive, although marginally so.”
Still, that’s not a whole lot to be happy about, unless you’re heavily invested in stocks, where the returns may be even worse, i.e., negative. The other so-called Bond King, Jeffrey Gundlach of DoubleLine Capital, predicted that the S&P 500 Index would end the year with a negative return. He also said that if the 10-year Treasury yield pushes past 2.63% – which it almost did last week – it will accelerate higher.
The news got worse after that.
Perhaps the biggest shot to the heart of the bond market came from China – the largest foreign holder of U.S. government bonds – where it was reported either as actual news or simply a rumor that the country was about to stop buying U.S. Treasury securities as retribution for President Trump’s constant bashing the country for currency manipulation, propping up North Korea, and cheating on trade deals. However, that was subsequently shot down by the country’s State Administration of Foreign Exchange, which said in a statement that the story "might have cited wrong sources or may be fake news.”
Then there was a story that the Bank of Japan – the second biggest U.S. government bondholder – had decided to reduce the size of its regular purchases of long-term debt, which basically piled onto the China story. That story also turned out to be false or at least exaggerated.
Whatever is true or not, the net effect on bond yields last week was pretty dramatic, but not enough to justify the panic, which seemed to dissipate as the week wore on.
The yield on the Treasury’s benchmark 10-year note ended the week at 2.56%, up about seven basis points on the week. Since hitting a recent low of 2.04% last September 7, the yield is up more than 50 bps, although it’s still some six bps below its one-year high of 2.62% reached last March 13. It’s also still well below the psychologically worrisome level of 3.0%, which it last hit more than four years ago.
The yield on the 30-year bond was also higher last week, but not enough to panic about. The yield ended the week at 2.85%, up only about four bps on the week. That’s still some 30-odd bps from its one-year high reached last March and more than 100 bps below its five-year high.
The fact that long-term yields are still way below where they were four years ago, even as we’ve heard nearly constant warnings during that time that the long bull bond market is done, tells me that the doomsayers may be wrong again. And the reason, of course, is that the alleged news driving rates higher isn’t true at all.
Still, it’s reasonable to ask why long-term rates aren’t, in fact, higher than they are, given the recent strong growth in the economy, the Federal Reserve reducing its balance sheet and the Treasury’s increased debt needs. Those argue strongly for higher long-term rates, yet they’re not happening.
According to long-term bond bull Gary Shilling, it’s because inflation simply isn’t as high or threatening as many would believe. (Question: Why isn’t Schilling, who has been beating the drums – correctly – for lower long-term bond yields since at least 1981, when the 30-year bond yield was in the mid-teens, also not known as the “Bond King?”)
“Inflation continues to undershoot the Fed’s 2% target,” he wrote in his most recent outlook. “The consensus of economists almost always predicts rising Treasury yields and is almost always incorrect.”
Personally, I think the rate of inflation is much higher than the Fed, Schilling and other doves think it is, but the fact is long-term bond rates are saying that inflation is still fairly non-existent, or at least below the Fed’s 2% target.
Yields at the short end of the curve are telling a different story. That’s something that should be worrisome.
Last week the rate on the two-year note jumped past 2.00% for the first time since the financial crisis in September 2008. That rate has been on a steady climb for the past several years. More recently, it’s up more than 140 basis points since July of 2016. Likewise, the three-month bill is up to 1.44%, up from just 0.17% since September 2016.
Given that U.S. economic growth seems to have consistently reached 3% this year, it seems reasonable to expect that long-term bond yields will follow along. Yet that doesn’t seem to be happening. I guess that means we need to obey that old adage: Don’t fight the bond market.
But for how long?
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.