The Bond Market's Take On The Economy

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by: John M. Mason

Summary

One month ago, the bond market seemed to be hoping for must faster growth connected with a picture of government programs coming from the newly-minted Trump administration.

These expectations have receded as reality seems to have settled into the market and this has resulted in a lower vision for the future growth of the US economy.

This picture of continued growth, albeit modest growth, will allow the Federal Reserve to operate in new territory with its enlarged balance sheet and "lower than normal" interest rates.

More slow economic growth?

That is what the bond market seems to be saying about the future growth of the US economy.

A month ago, the bond market seemed to be saying, watch out for more economic growth in the future and watch out for more inflation. The Trump administration was going to "goose up" the economy and there would be higher economic growth and inflation would break out of its slump.

On March 13, the yield on the 10-year US Treasury note closed above 2.60 percent. This level of rates was looked on as something of a "tipping point"... a level that contained the implication of even higher levels for yields.

The spur to this performance was the belief that there would be tax cuts, infrastructure spending and deregulation, all coming within a relatively short period of time.

On Friday, April 7, the yield on the 10-year note closed below 2.40 percent.

What's going on? Has the Trump program collapsed? Or, maybe the markets have just become more realistic?

Around March 13, the "real" yield on the 10-year Treasury, the yield on the Treasury Inflation Protected securities, TIPs, was just under 60 basis points.

Currently, this yield has dropped to 40 basis points or a little lower.

Writers for the Wall Street Journal, on the front page of the paper no less, suggest that "Investors" are "signaling that many remain skeptical about the prospects for faster economic growth…."

These investors seem to be growing more and more doubtful that any of the plans on tax reform, infrastructure spending or deregulation can be carried out in any short-term period of time.

Seems as if running a government is "a little more complex" than was originally thought.

Although suggestions have been made about how such an economic policy could be composed, there has been little forthcoming about what any coherent government program could be constructed, let alone passed by the US Congress.

What has happened in the markets is this (according to the Wall Street Journal article): "Companies and governments in emerging markets sold $178.5 billion of dollar-denominated debt in the first three months of the year, the best first quarter on record, according to data provider Dealogic. US companies with junk-bond ratings issued $79.6 billion, double a year earlier."

Furthermore, "Highly rated US companies issued $414.5 billion of debt during the first three months of the year. That was a record for any quarter."

Why all this activity?

Well, investors need yield. That yield is not coming from government issues, especially if the market now feels that the economy will not provide the growth rates and possible higher rates of inflation that were embedded in the Trump vision of the world.

These bonds that are being offered in such great numbers provide more yield than do the Treasury issues, and they are considered to offer less risk than do stocks. That is, they are the best alternative in terms of risk and return that is available in the market place at this time.

Alternatively, one could say that given slow growth prospects, the desperate "hunt for yield" goes on.

Issuers of bonds have responded to this demand.

In addition, investors must include in their picture of the world the dilemma now being faced by the Federal Reserve System. I believe that this attitude on the part of investors indicates an awareness that the Federal Reserve is going to be operating under a new central bank paradigm, one that must deal with a huge amount of debt on the Fed's balance sheet and a search for the "right" level of short-term interest rates.

This portends a world where the central bank does not continually underwrite inflated stock values, but also does not just dump securities from its portfolio back into the open market to achieve a "more normal" balance sheet… whatever that is in today's world.

The bond market seems to be taking a more realistic view of the world situation, now that the economy is approaching its ninth year of recovery. This world is one of only modest economic growth with very little room to achieve grandiose schemes. Not great… but, not too bad.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.