Stocks Favor Recovery... Bonds More Tepid
We hear from every corner of Washington that the recession is over. According to the stock market, a recovery is under way. But did someone forget to tell the bond traders?
Here are two recent U.S. Treasury yield curves – June 2009, when the recession (we’re told) was just beginning to end, and today, supposedly in the early stages of recovery.
We admit we’re not bond experts… but isn’t the yield curve supposed to grow and steepen when recovery is on the horizon? If Ben Bernanke is right and the recession is over, why are bonds in more demand now than three months ago?
“We remain concerned that little or none of the turn in the economy appears to be reflected in the Treasury bond market,” adds our macro adviser Rob Parenteau. “Treasuries have benefited of late from large purchasers who invest with little or no macro view — namely, the Fed, which has been rebuilding its Treasury holdings while slightly shrinking its balance sheet; foreign central banks, which have fled agencies and replaced them with Treasuries; and commercial banks, which have begun riding the yield curve with their mountain of excess reserves.
“If the short end of the Treasury curve begins to rise, the interest expense line item of the budget deficit will start to climb, as the Treasury has financed much of the recent public debt issuance at the very short end of the yield curve. Similarly, if the long end rises, mortgage rates are likely to follow, and any housing revival will get snuffed out in short order.
“So far, we have avoided these outcomes as the Fed, foreign central banks and commercial banks have placed the requisite bids for Treasuries, but we suspect this gets tougher in Q4 as the Fed’s quantitative easing comes to an end and the foreign central bank portfolio shift winds down.”