Even Bond Traders Don’t Believe This Rally

Robert Burgess
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Even Bond Traders Don’t Believe This Rally

(Bloomberg Opinion) -- Now we know. The rally in government bonds that pushed yields on benchmark 10-year notes down from more than 3.20 percent in November to less than 2.55 percent last week wasn’t a sign that the U.S. economy was about to roll over into recession. Instead, like the jaw-dropping plunge in stocks, chalk the move up to exaggerated year-end positioning changes and other quirky market structure forces such as short covering. Just ask bond traders.

The U.S. Treasury Department’s auction on Tuesday of $38 billion of three-year notes drew bids for just 2.44 times the amount offered, the lowest so-called bid-to-cover ratio since 2009. The sale came just a few days after yields on three-year notes fell below the Federal Reserve’s target for overnight interest rates in a phenomenon last seen in 2008. Before the auction, a widely followed JPMorgan Chase & Co. weekly survey showed that bond investors went from being bullish on Treasuries to bearish in the biggest reversal in sentiment since June. That’s not to say that economic growth won’t decelerate, because it will, and there’s enough that could go wrong, such as a prolonged U.S. government shutdown or a glitch in the U.S.-China trade talks or a worsening euro zone economy, that could keep demand for government debt high. But even normally pessimistic bond traders realize it’s too soon to be pricing in a recession. And while Wall Street banks are busy slashing their forecasts for how high yields will rise, the new estimates are still far above current market rates. Goldman Sachs Group Inc. just lowered its year-end projection for 10-year yields by 50 basis points to 3 percent, which compares with the current yield of 2.72 percent. JPMorgan is at 3.20 percent, down from its prior estimate of 3.60 percent.

STOCKS AND PICKUP TRUCKS  Like bond traders, stock traders seem to be re-evaluating their extreme pessimism. As JPMorgan strategists noted, the recent slump in equities suggested that investors were pricing in about a 60 percent chance of a typical recession this year. But stocks are suddenly looking lively. The S&P 500 Index has managed its first three-day rally since November, rising about 9.35 percent from last year’s low on Christmas Eve. The National Federation of Independent Business monthly index of sentiment among small U.S. businesses, released Tuesday, showed only a slight decline for December, to 104.4 from 104.8 in November. That’s well above the five-year average of 98.5, indicating business owners remain relatively optimistic overall. And then there’s the pickup truck indicator. DataTrek Research outlined in a research note to clients on Tuesday that sales of large pickup trucks “remain surprisingly robust.” “The key buyers here — small businesses — clearly still feel positive about their near-term outlook,” DataTrek co-founder Nicholas Colas wrote. “Yes, lower gas prices are helping, but this is one group that knows such trends can reverse quickly. If they are still buying big pickups — and they are — then things aren’t as bad as last month’s sell-off indicated.” Light trucks surged to about 70 percent of the U.S. sales mix in 2018, an unprecedented level, according to Bloomberg News. Colas noted that in late 2007 and early 2008 the “large pickup truck indicator” foretold the deep recession to come. Sales started to slow in the fourth quarter of 2007 and by late in the following first quarter, sales were down 22 percent. “That was all you needed to know that the U.S. economy was slowing quickly,” Colas wrote.

IT’S HAPPENINGAround the middle of 2018, investors began to notice that cash was starting to become a competitive and attractive asset class for the first time since before the financial crisis. That’s largely due to tighter monetary policy by the Federal Reserve, which has now raised its target for the federal funds rate nine times since December 2015. While this is good news for savers, it’s not particularly favorable for the outlook of other assets such as stocks and bonds that compete for investor funds, which could be headed to cash-like instruments. Indeed, it’s already happening. Assets in money market funds surged by $155.5 billion in the fourth quarter to $3.04 trillion. That’s the biggest increase since December 2008, when huge losses in equities, credit and other markets following Lehman Brothers’ bankruptcy sent investors fleeing to cash. The attractiveness of cash is undeniable. At one point last week, rates on three-month Treasury bills were just 15 basis points below yields on 10-year Treasury notes. And even with the recent sell-off in stocks, the average dividend yield for members of the S&P 500 Index is only about 0.83 percentage point higher than rates on 12-month certificates of deposit as measured by Bankrate.com. Just a couple of years ago, the gap was about 1.60 percentage points. Yes, a lot of the cash flowing into money funds is likely from investors fleeing last quarter’s big losses in stocks, but the relatively attractive rates paid by money funds may keep the cash parked there longer than it normally has in the recent past.

CANADA’S HURTINGThe Bank of Canada has been largely in line with the Fed in normalizing monetary policy. It has raised benchmark interest rates five times since mid-2017, taking them from 0.5 percent to 1.75 percent. But since the last hike on Oct. 24, Canada’s economic outlook has weakened, and moves in the nation’s currency suggest there’s unlikely to be a rebound any time soon. Since peaking last year on Oct. 3, the Bloomberg Correlation-Weighted Index for the Canada dollar, which measures the so-called loonie against a basket of nine other major currencies, has dropped about 3.50 percent. That compares with little change for a similar index covering the U.S. dollar. There’s evidence that the rate increases are taking their toll. The number of consumers seeking debt relief jumped 5.1 percent to 11,320 in November from a year earlier, the Ottawa-based Office of the Superintendent of Bankruptcy reported on Jan. 4. October and November combined experienced 22,961 consumer insolvency filings, the most for those two months since at least 2011, according to Bloomberg News’s Chris Fournier. BlackRock Inc., the world’s biggest money manager, expects the Bank of Canada to refrain from raising rates this year. While that may bolster Canada’s bonds, the currency might suffer. Morgan Stanley is a contrarian. The firm’s currency strategists issued a research note Tuesday recommending Canada’s dollar against the U.S. greenback, noting that traders are underpricing the risk that the Bank of Canada sends a hawkish message when it meets to decide rates Wednesday.

POLITICS MATTERTurkey’s lira was the world’s worst performing currency Tuesday, falling about 2 percent and providing yet another reminder of just how unpredictable investing in emerging markets can be. The move lower in the lira followed a fourth-quarter rebound when Turkey released American pastor Andrew Brunson, who had been detained on terrorism and espionage charges, to the U.S. Also, there were signs that Turkey’s economy was on the mend after taking a hit as President Recep Tayyip Erdogan tightened his grip on power. But now traders are back worrying about relations between the U.S. and Turkey after Erdogan rebuffed a meeting in Ankara on Tuesday with U.S. National Security Adviser John Bolton and then took to live television instead to insult him for a lack of perspective. The U.S. and Turkey run the largest armies in NATO and are at odds about how to handle Syria. Also, at about $850 billion, Turkey has one of the largest emerging-market economies, while its currency is traded around the clock. That makes it a bellwether for emerging-market investors, and any dampening of sentiment toward the country could have a ripple effect. Emerging-market currencies overall fell from their strongest level since July on Tuesday as measured by the MSCI Emerging Markets Currency Index.

TEA LEAVESWhen the Fed raised interest rates for the fourth time last year on Dec. 19, Chairman Jerome Powell signaled that the central bank saw little threat to the economy from the spreading turmoil on financial markets. More specifically, Powell acknowledged that financial conditions had tightened but stressed that weakness in assets such as stocks, corporate debt and commodities was just “a little bit of volatility.” Was that really what Powell meant to say, or did he just bungle the message, sending risk assets further into a tailspin over the following week? Market participants may find out Wednesday when the Fed releases the minutes of that Federal Open Market Committee meeting. Powell’s comments also seemed in conflict with the so-called dot plot of how high rates may get. The expected trajectory of rates in 2019 shifted a bit lower, as did estimates for the neutral and terminal federal funds rates. As such, Bloomberg Economics figures the minutes could provide details about whether it was rising global risks, financial market volatility or the lack of inflationary pressures that required a more modest pace of removal of policy accommodation.

DON’T MISS Bolton’s Syria Snafu Reveals Oil’s Biggest Risk: Liam Denning Don’t Weaponize Liang’s Open Spot on Fed Board: Daniel Moss WeWork’s Junk Bonds Are Telling Us Plenty: Laurent and Ashworth Don’t Be Fooled by China’s Old Debt Playbook: Anjani Trivedi Venture Capital Keeps Flowing to the Same Places: Justin Fox

(Corrects the size of Turkey’s economy in the sixth paragraph.)

To contact the author of this story: Robert Burgess at bburgess@bloomberg.net

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Robert Burgess is an editor for Bloomberg Opinion. He is the former global executive editor in charge of financial markets for Bloomberg News. As managing editor, he led the company’s news coverage of credit markets during the global financial crisis.

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