The Bond Market Looks Nervous And Yields May Drop Soon

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Includes: CMU, CXE, HYD, HYMB, MAV, MHF, MHI, NMZ, SHYD
by: D. H. Taylor

Summary

Three weeks ago 10-year yields were 2.60%. Now, they have fallen to 2.305.

Selling may be heading to the stock market and bond yields may drop even more.

There is continued turbulence in the political environment here in the United States as well as France.

The bond market is worried. Three weeks ago, right when the Federal Reserve was raising interest rates, the 10-year government bond was trading at 2.60%. Now, in a signal that Trumponomics may not be panning out, the 10-year is back down to 2.30% and the stock market appears to be stuck in the mud for now. This is likely a warning of what is to come: stocks will decline and bond will yields drop.

I have said this multiple times that the Republican Party's failure to pass their number one key signature campaign promise spells doom in a lot of ways. For years, the Republicans in congress have sent far too many bills to repeal Obamacare to be immediately vetoed by President Obama. But, when it came down to it, with both houses of congress in Republican control and a new president hell bent on repealing the legislation, the bill never even made it out of committee.

From that, it is easy to rationalize that there is no cohesiveness in the Republican Party. Trumponomics are not likely able to deliver the much needed stimulus in the form of tax reform, infrastructure spending and deregulation necessary to get the United States economy out of the doldrums that it has been stuck in for the past few years.

This, from a trader at BMO, via CNBC:

"Generally speaking, the rally we've seen over the course of the last three weeks, or effectively, since the March FOMC meeting, has been a function of people rethinking Trumponomics and the potential for the administration to deliver anything in terms of real economic growth in the near to medium term," said Ian Lyngen, head of U.S. rates strategy at BMO.

Given this sentiment in the bond markets, the stock market could easily sell off sharply. Remember, it was just three weeks ago that the Fed raised interest rates. Now, the 10-year is already down 30 basis points. Bond rates should not have fallen as much as they have in that short of time.

With the fall in bond yields, there should have also been a corresponding move lower in the stock market. One, or the other, the bond market or the stock market, is going to have to give up some ground. Given the sharp run-up in the equity markets, it would be hard to justify these lofty price/earnings ratios without future stimulus. My sentiment is that the bond market is getting ahead of the stock market but that equities will fall soon.

I can see infrastructure spending getting through Congress. In fact, I am one how believes that the country is in dire need of such a plan. However, Trump is expected to propose $1 trillion in spending on infrastructure. That just sounds painful. Granted, as I mentioned, I believe the country could use a substantial amount of spending on roads and bridges. I just do not see the Congress agreeing to spending that much.

When the official news of this proposal hits, it will very likely push the stock market up higher. Why not? If that much money is going to be spent around the country improving the ability of goods and people to travel quicker, it will be good for the economy.

But, $1 trillion is a bit unrealistic and too ambitious, and just like the repeal and replace, will fail. Then, the markets will start to see that Trumponomics will never pan out.

As for deregulation, this actually is in the works and likely the economy will see results with this. Trump has signed several executive orders that are rolling back environmental regulations from Obama. But, this is hardly enough to justify the high Price/Earnings ratios that the stock market has hit.

The bond market certainly sees the writing on the wall. The stock market is not quite there yet. I think it is a matter of time before the stock market starts inching down. Then, it will give a bit more and then a bit more. Then, boom. It is possible the market could correct to levels below the pre-election rally in the Dow, taking it below 17,750. And that will be the end of and credibility in Trumponomics.

Disclosure: I am/we are short U.S GOVERNMENT BONDS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.