Reading or hearing about government bonds can be boring for many investors because they’re not as sexy as stocks.
But there are times when bonds and their movements really matter, which is now.
Short-term U.S. Treasury yields continue to surge as investors price in higher interest rates.
U.S. Federal Reserve chairman Jerome Powell seems determined to raise interest rates aggressively as exemplified by his hint on Monday the Fed may move its key rate up by 50 basis points at their next meeting in May.
The market is ramping up expectations that the Fed is going to hike rates as many as eight times this year.
On the other end of the spectrum there are definite signs the central bank may be leading the economy straight into a recession.
At the same time, the bond market is pricing in what amounts to a recession in about a year’s time.
That’s presaged by the chart below, courtesy of John Johnston, Economic Advisor, Davis Rea Investment Counsel.
It compares the U.S. Treasury two-year and 10-year yields, which is down to sixteen basis points, as of this writing.
And looks at the three-month Treasury bill and the 10-year, which Johnston says “picks up actual and not expected Fed rate moves.”
Even more ominous is the chart below.
As of last Friday, traders, based on overnight index swaps* comparing one year expectations of 10-year and two-year Treasury yields, believe that the yield curve is going to invert (two-year yield above the 10-year yield), which usually indicates a recession is coming.
The inversion as of today is 37 basis points.
So short-term yields are reflecting higher rates from the Fed and longer term yields are indicating economic slowdown prospects.
Couple that with the fact that oil, copper, and commodities in general are all showing lower highs on their charts from recent peaks.
Lumber, in fact, has crashed 43 per cent from its high.
What does all this mean?
There are conflicting signals right now but starting in April, economic growth, inflation, and corporate profit numbers are all going to start decelerating meaningfully compared to last year’s lofty numbers.
That will be disinflationary, not inflationary.
U.S. earnings growth is set to decelerate to 4.8% year-on-year in the current quarter, its slowest pace since the final quarter of 2020, according to FactSet.
So despite the consternation about higher prices maybe, in a general sense, they’ve peaked already.
And the more important thing to focus on is a growth slowdown.
The last word goes to John O’Connell.
The Chairman, CEO & CIO of Davis Rea Investment Counsel, the sponsor of Uncommon Sense Investor, pays attention to the yield curve but is wary of reading too much into it:
“Inverted yield curves don’t cause recessions, they are investors’ expectations about where interest rates will be at points in time.
With bond investors experiencing the worst of times in most of their professional experience, don’t get too caught up in the short term expressions of traders.
Keep your eye on the consumer. They are the ones who drive the outcomes bond ‘gurus’ are trying to anticipate.”
*Overnight Index Swaps (OIS) are interest rate swaps based on a specific currency that exchanges fixed rate interest payments for floating rate payments based on a notional swap principal at regular intervals over the life of the swap contract.
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