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The Bond Market Begins To Figure Things Out

Calafia Beach Pundit profile picture
Calafia Beach Pundit

For the past year the stock market has had a blast pricing in tax reform. The S&P 500 is now up some 25% or so since the day before the November '16 election, and that gain is only slightly more than the degree to which a cut in the corporate tax rate, from 35% to 21%, causes a one-time rise in after-tax corporate profits. (Here's the equation: (1-.21)/(1-.35) = 21.5%.) The bond market, however, hasn't taken much notice: 10-yr Treasury yields today are 2.45%, only modestly higher than the 2.33% they have averaged over the past year. On the other hand, 5-yr real yields on TIPS (a key, must-watch indicator as I've argued), today have climbed to 0.37%, which is meaningfully higher than the 0.05% they have averaged over the past year. The rise in bond yields is still modest, but the rise in real yields is better still, since it's the best indicator that the bond market is beginning to price in a stronger economy. And we're still in the early innings. Bond investors, hold on to your hats.

I first raised this issue - how the stock market was excited about tax reform, but the bond market was ignoring the likely consequences - in a post two weeks ago (Tax reform is priced in, but not a stronger economy). It now looks like the bond market is in the early stages of figuring out that a big cut in corporate tax rates is indeed likely to result in an investment boom and a stronger economy in the years to come. The ranks of the Trump despisers have been thinning ever since the summer of 2016, as more and more become convinced he is going to adopt more business- and growth-friendly policies, and the bond market is now beginning to join the

This article was written by

Calafia Beach Pundit profile picture
Scott Grannis was Chief Economist from 1989 to 2007 at Western Asset Management Company, a Pasadena-based manager of fixed-income funds for institutional investors around the globe. He was a member of Western's Investment Strategy Committee, was responsible for developing the firm's domestic and international outlook, and provided consultation and advice on investment and asset allocation strategies to CFOs, Treasurers, and pension fund managers. He specialized in analysis of Federal Reserve policy and interest rate forecasting, and spearheaded the firm's research into Treasury Inflation Protected Securities (TIPS). Prior to joining Western Asset, he was Senior Economist at the Claremont Economics Institute, an economic forecasting and consulting service headed by John Rutledge, from 1980 to 1986. From 1986 to 1989, he was Principal at Leland O'Brien Rubinstein Associates, a financial services firm that specialized in sophisticated hedging strategies for institutional investors. Visit his blog: Calafia Beach Pundit (http://scottgrannis.blogspot.com/)

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Comments (5)

Michael Roat profile picture
Excellent article. Bond market finally re-pricing. Metals look vulnerable.
Gary Jakacky profile picture
I love the proof that the stock rally is tax based. No doubt the 5th grade arithmetic is beyond the kin of Trump haters, so I am sure they missed the entire rally.

After eight years of a "2% growth is the new normal," lets see what happens in the next few years.

The new whining shibboleth is..."Oh my! HE got a bigger tax cut than I did!" Waaaaaaaa!
The ranks of the Trump despisers have been thinning ever since the summer of 2016, as more and more become convinced he is going to adopt more business- . LOL
A guy just wanted to short 100 Ultrabond contracts. Im taking the other side. Got him to pay up too. There aren't enough plebians in the US economy to fuel any growth.
Charles Agbakwu profile picture
Inflation doesn't necessarily mean growth. As Stan Druckenmiller pointed out in a recent interview there have been plenty of periods where there has been outright deflation coupled with real growth and viceversa. If bonds are selling off it merely means investors expect higher inflation in the future, nothing else.
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