U.S. economy may face trouble if ‘sideways’ Treasury trade doesn’t end
Don’t be lulled into complacency by a newfound calm in Treasury markets.
That’s the warning from Jim Vogel of FTN Financial, who wrote in a Thursday note that if the current “sideways” trading takes hold in government bond trading for too long, that placidity could serve as a more troublesome sign of the economy’s prospects.
That’s because if the bond market spends an extended period at the current level of quiescence, it suggests that the usual bounceback in growth after the first quarter of the year may not pan out, removing a catalyst for higher yields. Bond prices fall as yields climb.
“The unfortunate problem, if ‘sideways’ extends too far, is the implication economic momentum is stalling. The pattern of the last two years has been growth picks up after a quarter of slower activity,” wrote Vogel. “That doesn’t make it automatic, however.”
Gross domestic product tends to accelerate in the second quarter after a slow first three months of the year, according to the Cleveland branch of the Federal Reserve.This seasonal trend has contributed to yields climbing toward the summer before tailing off. But if yields fail to shift higher from current levels, it could portend a gloomy economic outlook, as it would imply investors hold doubts that growth will rebound after spring.
After sharp twists and turns in December, the 10-year Treasury note yieldTMUBMUSD10Y, +1.01% has stabilized above 2.70% and is now trading at 2.749%, according to Tradeweb data. A steady rise for U.S. stocks, with the S&P 500 SPX, +0.76% up more than 11% since the Christmas Eve rout, subdued rapid inflows and outflows into haven assets like bonds.
A gauge of implied volatility for the Treasury market in the past month, the one-month Merrill Lynch MOVE index, has fallen sharply from an 10-month high of 68.34 in Dec. 27 to 51.95 on Wednesday.
Economists polled by the Wall Street Journal expect the U.S. economy to speed up to an annualized 2.4% growth in the second quarter of 2019 from an expected 2.2% in the current quarter, albeit these estimates are lower than those of a few months ago, after fears a weaker global economy would put the brakes on U.S. momentum. However, domestic growth has so far proven resilient amid signs of economic contraction abroad.
At the moment, the quiet trading has given investors a respite from volatility. That has given Wall Street the encouragement to start buying bonds in riskier fixed-income markets like corporate bonds, helping to tighten yield premiums for sub-investment grade bonds.
“Range trading reduces the rate shocks fixed-income portfolio managers should be using to test the price risk of purchases this year,” said Vogel.
The spread between high-yield corporate debt and safer Treasurys has narrowed to 4.44 percentage points after spiking as high as 5.44 basis points on Jan. 3., according to an index provided by ICE Data Services.
See: U.S. economy could slip from top spot in 2020 and keep slipping, analysts say
Read: Why these bond investors suspect the 10-year Treasury yield has peaked
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