Bonds: Total Market
The bond market is doing something that it usually doesn’t—it is scaring stocks. Generally speaking, big sell offs in stocks drive moves in bonds, but rarely do moves in bonds spook stocks. Except for right now, that is. The ten-year yield dropped to 1.48% recently, below the two-year’s 1.51%, signaling another 2y-10y inversion which is a classic recession indicator. But the 3m-10y is even scarier as it touched a fresh new low of negative 51 basis points.
FINSUM: The bond market thinks a recession is coming and that Fed policy is too tight. The velocity with which that sentiment is driving yields is spooking stocks, and rightly so.
The inverted yield curve may be odd, and negative yields in Europe may be strange, but the weirdest current perversion of markets (or is it the “new normal”?) is in Denmark specifically. That oddity is the negative rate mortgage. Yes, homebuyers are getting paid to take out mortgages to buy a home. Jyske Bank, Denmark’s third largest lender, is offering a mortgage rate of -.50% before fees.
FINSUM: So this is already happening in Europe, but it may have limited effects given the continent’s demographic struggles. It is hard to imagine this happening in the US, but if it did, we bet it would cause a housing boom.
Bloomberg has published a very insightful article about the current state of the market. In particular, it offers a view of how the big run up in bonds is likely to end. The fears that are driving the bond market—mostly that de-globalization will cause a recession—can only end two ways. Either the recession and de-globalization never materialize, in which case yields shoot back up, causing big losses in bonds. Or, the breakdown of global trade does happen, In this scenario, goods likely become significantly more expensive (especially in west) because there is no more labor and cost arbitrage. In this scenario, inflation then jumps, again sending yields much higher and sparking losses. In other words, the current bond market can only end in tears.
FINSUM: This was a very insightful argument in Bloomberg today. While there are some nuances that might cause some different outcomes, the basic contention is quite astute. Stocks seems a much better bet.
Every investor seems to be panicking about the yield curve right now, and not without reason. An inverted yield curve has accurately predicted each of the last several recessions. And not only is the yield curve inverted, but yields are shockingly low—the 30-year Treasury yield just went sub-2% for the first time ever. However, that is not what you should be worried about, argues a top economist at the Economic Outlook Group. Instead, you should be watching consumers like a hawk, as they will be the deciding factor as to whether the US heads into a recession. “All eyes should therefore be laser focused on what households are thinking and doing in the coming months--- and not on some tampered yield curve”, says Bernard Baumohl, chief global economist at the Economic Outlook group.
FINSUM: The yield curve is less manipulated than it once was, but we are far from a rate environment one could say was comparable to inversions past. We think this analysis is spot on.
Right now is high time for investors to be worried about bonds. Bond funds have received a lot of fast money in recent months because of the well-telegraphed rate cut. According to BAML, the net inflows into fixed income funds have reached a “staggering record” of $455 bn in 2019. That compares to just $1.7 tn in the last decade. Yields have tumbled this year, with ten-year yields down from 3.2% in November to just 2.06% now.
FINSUM: The outlook for bonds got murkier yesterday with the Fed’s relative lack of dovishness. It is not entirely clear that rates are going to keep falling, so it is not hard to imagine bonds facing some losses now given how much speculation there was of a large Fed rate-cutting program.
The broad expectation is that rate cuts will boost all bonds. To some degree this is likely true. However, not all bonds will be affected to the same degree. For instance, safe bonds—think investment grade corporates and Treasuries—have likely already seen most of the gains they will. But high yields are a different story, as they are much more likely to see a decent rally, as lower borrowing costs are a bigger boon to those companies and the cuts themselves will help sustain the economic cycle, which is more important for them than for ultra-safe companies.
FINSUM: This seems to be pretty good analysis. This rate cut has been widely projected and safe bonds have already seen gains, so junk may be the biggest beneficiary.